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An Anatomy of the Equity Premium

Paul Schneider ()

No 15-61, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: This paper introduces a decomposition of the market return in terms of higher-order realized, and option-implied risk aversion, connecting it to level, slope, and curvature of the implied volatility surface. Empirically, second-order risk aversion -- loss aversion -- explains most of the market return. Signals revealed by this risk anatomy provide predictive power out-of-sample for realized returns in particular for longer maturities. The decomposition also shows that compensation for disaster risk is not prominently featured in the market return. Furthermore it highlights that models with identically and independently distributed state variables are not suited to represent in particular longer-maturity returns.

Keywords: equity premium; model-free; risk aversion; skewness (search for similar items in EconPapers)
JEL-codes: C02 C23 C52 C61 G11 G12 (search for similar items in EconPapers)
Pages: 41 pages
Date: 2015-12
New Economics Papers: this item is included in nep-fmk, nep-rmg and nep-upt
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