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Implications for Asset Pricing Puzzles of a Roll‐over Assumption for the Risk‐Free Asset *
Author(s) -
WARREN GEOFFREY J.
Publication year - 2008
Publication title -
international review of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.489
H-Index - 18
eISSN - 1468-2443
pISSN - 1369-412X
DOI - 10.1111/j.1468-2443.2008.00079.x
Subject(s) - risk free interest rate , equity premium puzzle , economics , risk premium , capital asset pricing model , consumption based capital asset pricing model , basis risk , asset (computer security) , consumption (sociology) , risk aversion (psychology) , cash , financial economics , econometrics , actuarial science , expected utility hypothesis , finance , social science , computer security , sociology , computer science
The equity risk premium and risk‐free rate puzzles are largely resolved by combining persistent uncertainty over the long‐term consumption growth rate with analysis of the risk‐free asset on a ‘roll‐over’ basis. Under these conditions, cash equivalents are evaluated as a multi‐period investment strategy that hedges against adverse growth rate outcomes. The premium on the risky asset is raised and the risk‐free rate lowered due to their respective relation with multi‐period consumption risk. Historical average asset returns are matched at plausible risk aversion.