Dissecting the Equity Premium

Tyler Beason and David Schreindorfer

Journal of Political Economy, 2022, vol. 130, issue 8, 2203 - 2222

Abstract: We use option prices and realized returns to decompose risk premia into different parts of the return state space. In the data, 8/10 of the average equity premium is attributable to monthly returns below −10%, but returns below −30% matter very little. In contrast, prominent asset pricing models based on habits, long-run risks, rare disasters, undiversifiable idiosyncratic risk, and constrained intermediaries attribute the premium predominantly to returns above −10% or to the extreme left tail. We show that the discrepancy arises from an unrealistically small price of risk for stock market tail events in the models.

Date: 2022
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