A Puzzle of Excessive Equity Risk Premium and the Case of Poland

e-Finanse ◽  
2016 ◽  
Vol 12 (1) ◽  
pp. 1-11
Author(s):  
Paweł Kliber
Keyword(s):  
Financial Markets ◽  
Risk Premium ◽  
Historical Review ◽  
Theoretical Models ◽  
Equity Risk ◽  
The Difference ◽  
Using Data ◽  
Risk Free Rate ◽  
Excessive Risk ◽  
Free Rate

AbstractThe article presents a historical review of the literature related to the empirical problem of excessive risk premium. The risk premium (the difference between the return on equities and risk-free rate) observed in financial markets cannot be reconciled with theoretical models of financial markets - it is too high (“excessive”). We present the original model from the seminal work of Mehra and Prescott (1985), where this problem has been signaled. The article gives an overview of the main trends in the literature concerning this problem, of the proposed solutions and of the extension to the model. Finally, we consider the problem in the Polish context, estimating the original Mehra-Prescott model using data from the Polish financial market.

Principles for modelling financial markets

1996 ◽  
Vol 33 (03) ◽  
pp. 601-613 ◽  
Author(s):  
Eckhard Platen ◽  
Rolando Rebolledo
Keyword(s):  
Financial Markets ◽  
Financial Market ◽  
Real World ◽  
Market Model ◽  
Rate Of Return ◽  
Probability Measures ◽  
Market Clearing ◽  
The Difference ◽  
Risk Free Rate ◽  
Free Rate

The paper introduces an approach focused towards the modelling of dynamics of financial markets. It is based on the three principles of market clearing, exclusion of instantaneous arbitrage and minimization of increase of arbitrage information. The last principle is equivalent to the minimization of the difference between the risk neutral and the real world probability measures. The application of these principles allows us to identify various market parameters, e.g. the risk-free rate of return. The approach is demonstrated on a simple financial market model, for which the dynamics of a virtual risk-free rate of return can be explicitly computed.

scholarly journals How Much Do Investors Care About Macroeconomic Risk? Evidence from Scheduled Economic Announcements

2013 ◽  
Vol 48 (2) ◽  
pp. 343-375 ◽  
Author(s):  
Pavel Savor ◽  
Mungo Wilson
Keyword(s):  
Interest Rates ◽  
Risk Premium ◽  
Asset Returns ◽  
Precautionary Saving ◽  
Macroeconomic News ◽  
Macroeconomic Risk ◽  
Equity Risk ◽  
Sharpe Ratios ◽  
Risk Free Rate ◽  
Free Rate

AbstractStock market average returns and Sharpe ratios are significantly higher on days when important macroeconomic news about inflation, unemployment, or interest rates is scheduled for announcement. The average announcement-day excess return from 1958 to 2009 is 11.4 basis points (bp) versus 1.1 bp for all the other days, suggesting that over 60% of the cumulative annual equity risk premium is earned on announcement days. The Sharpe ratio is 10 times higher. In contrast, the risk-free rate is detectably lower on announcement days, consistent with a precautionary saving motive. Our results demonstrate a trade-off between macroeconomic risk and asset returns, and provide an estimate of the premium investors demand to bear this risk.

scholarly journals The CCAPM with Varying Preferences

2017 ◽  
Vol 12 (2) ◽  
pp. 199
Author(s):  
Samih Antoine Azar
Keyword(s):  
Risk Aversion ◽  
Euler Equation ◽  
Risk Premium ◽  
Capital Asset Pricing ◽  
Long Run ◽  
Short Run ◽  
The Difference ◽  
Risk Free Rate ◽  
Long Run Risk ◽  
Free Rate

The Consumption Capital Asset Pricing Model (CCAPM) is by now a paradigm in financial economics. Applied to the risk-free rate, the CCAPM implies an Euler equation which depends on expected marginal utilities. The paper uses a widespread functional form to specify the utility. However the paper introduces varying preferences into the Euler equation. This enables us to find a relation between the current risk-free rate and the current level of real per capita consumption. Empirically this relation finds that risk aversion is lower for the short run and higher for the long run. The difference between the two is economically small but it is still statistically significant. The paper calculates the differential risk premium required to compensate for the higher long run risk aversion. This premium is also economically small. The paper concludes that the evidence supports that, in the long run, risk is either the same or higher than the short run risk.

Principles for modelling financial markets

1996 ◽  
Vol 33 (3) ◽  
pp. 601-613 ◽  
Author(s):  
Eckhard Platen ◽  
Rolando Rebolledo
Keyword(s):  
Financial Markets ◽  
Financial Market ◽  
Real World ◽  
Market Model ◽  
Rate Of Return ◽  
Probability Measures ◽  
Market Clearing ◽  
The Difference ◽  
Risk Free Rate ◽  
Free Rate

The paper introduces an approach focused towards the modelling of dynamics of financial markets. It is based on the three principles of market clearing, exclusion of instantaneous arbitrage and minimization of increase of arbitrage information. The last principle is equivalent to the minimization of the difference between the risk neutral and the real world probability measures. The application of these principles allows us to identify various market parameters, e.g. the risk-free rate of return. The approach is demonstrated on a simple financial market model, for which the dynamics of a virtual risk-free rate of return can be explicitly computed.

scholarly journals Earnings Expectations during the COVID-19 Crisis*

2020 ◽  
Vol 10 (4) ◽  
pp. 598-617 ◽  
Author(s):  
Augustin Landier ◽  
David Thesmar
Keyword(s):  
Risk Premium ◽  
Earnings Forecasts ◽  
Earnings Expectations ◽  
Forecast Revisions ◽  
Asset Risk ◽  
Equity Values ◽  
Oxford University ◽  
Risk Free Rate ◽  
Published Paper ◽  
Free Rate

Abstract We analyze the dynamics of earnings forecasts and discount rates implicit in valuations during the COVID-19 crisis. Forecasts over 2020 earnings have been progressively reduced by 16%. Longer-run forecasts have reacted much less. We estimate an implicit discount rate going from 8.5% in mid-February to 11% at the end of March and reverting to its initial level in mid-May. Over the period, the unlevered asset risk premium increases by 50bp, the leverage effect also increases by 50bp, while the risk free rate decreases by 100bp. Hence, analysts’ forecast revisions explain all of the decrease in equity values between January 2020 and mid-May 2020. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

scholarly journals CONNECTING THEORY AND EMPIRICS FOR ANIMAL SPIRITS, RETURNS AND INTEREST RATES: A CLARIFICATION OF “RISK-FREE RATES AND ANIMAL SPIRITS IN FINANCIAL MARKETS”

2017 ◽  
Vol 12 (01) ◽  
pp. 1750002 ◽  
Author(s):  
JUKKA ILOMÄKI
Keyword(s):  
Financial Markets ◽  
Interest Rates ◽  
Expected Returns ◽  
Animal Spirits ◽  
Empirical Results ◽  
Upper Limit ◽  
Risk Free Rate ◽  
Free Rate

I clarify and combine the results of Ilomäki (2016a) and Ilomäki (2016b) and find several interesting conclusions. First, the effect of the animal spirits component to the expected returns of investors depends on the risk-free rate. Second, there must be an upper limit for the risk-free rate, where the component that reduces the expected returns of informed investors in Ilomäki (2016a) disappears. Third, the empirical results of Ilomäki (2016b) indicates that the break-even level is as low as 3%.

IMPLICATION OF THE KELLY CRITERION FOR MULTI-DIMENSIONAL PROCESSES

2010 ◽  
Vol 13 (01) ◽  
pp. 93-112 ◽  
Author(s):  
YINGDONG LV ◽  
BERNHARD K. MEISTER
Keyword(s):  
Financial Markets ◽  
Diffusion Processes ◽  
General Setting ◽  
Optimal Investment ◽  
Investment Strategy ◽  
Short Term ◽  
Kelly Criterion ◽  
Optimal Investment Strategy ◽  
Risk Free Rate ◽  
Free Rate

In this paper, we study the Kelly criterion in the continuous time framework building on the work of E.O. Thorp and others. The existence of an optimal strategy is proven in a general setting and the corresponding optimal wealth process is found. A simple formula is provided for calculating the optimal portfolio in terms of drift, short term risk-free rate and correlations for a set of generic multi-dimensional diffusion processes satisfying some simple conditions. Properties of the optimal investment strategy are studied. The paper ends with a short discussion of the implications of these ideas for financial markets.

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