The intrinsic bounds on the risk premium of Markovian pricing kernels

Jihun Han and Hyungbin Park

Finance Research Letters, 2015, vol. 13, issue C, 36-44

Abstract: The risk premium is one of main concepts in mathematical finance. It is a measure of the trade-offs investors make between return and risk and is defined by the excess return relative to the risk-free interest rate that is earned from an asset per one unit of risk. The purpose of this article is to determine upper and lower bounds on the risk premium of an asset based on the market prices of options. One of the key assumptions to achieve this goal is that the market is Markovian. Under this assumption, we can transform the problem of finding the bounds into a second-order differential equation. We then obtain upper and lower bounds on the risk premium by analyzing the differential equation.

Keywords: Risk premium; Markovian pricing kernel; Intrinsic bounds (search for similar items in EconPapers)
JEL-codes: C52 C58 G12 G13 (search for similar items in EconPapers)
Date: 2015
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finlet:v:13:y:2015:i:c:p:36-44

DOI: 10.1016/j.frl.2015.03.005

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