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Dissecting the Equity Premium

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  • Tyler Beason
  • David Schreindorfer

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.

Suggested Citation

  • Tyler Beason & David Schreindorfer, 2022. "Dissecting the Equity Premium," Journal of Political Economy, University of Chicago Press, vol. 130(8), pages 2203-2222.
    • Handle: RePEc:ucp:jpolec:doi:10.1086/720396
    DOI: 10.1086/720396
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    Cited by:

    1. Steven Heston & Kris Jacobs & Hyung Joo Kim, 2023. "The Pricing Kernel in Options," Finance and Economics Discussion Series 2023-053, Board of Governors of the Federal Reserve System (U.S.).
    2. Geert Bekaert & Eric Engstrom & Andrey Ermolov, 2023. "The Variance Risk Premium in Equilibrium Models," Review of Finance, European Finance Association, vol. 27(6), pages 1977-2014.
    3. Bollerslev, Tim & Todorov, Viktor, 2023. "The jump leverage risk premium," Journal of Financial Economics, Elsevier, vol. 150(3).
    4. Kroencke, Tim A., 2022. "Recessions and the stock market," Journal of Monetary Economics, Elsevier, vol. 131(C), pages 61-77.

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