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The Risk Premium on the Euro Area Market Portfolio: The Role of Real Estate

Thomas Nitschka

Swiss National Bank

August 2008

IEW Working Paper No. 385

Incomplete consumption risk sharing implies that the market risk premium is high in times of lack of risk sharing and vice versa. In the time period from 1980 to 2007, this implication of incomplete consumption risk sharing for the market price of risk is not mirrored in excess returns on stocks but in returns on real estate both in the Euro Area and in the U.S. This finding thus casts doubt on the common practice to approximate the market return by a stock index return in empirical tests of the Sharpe-Lintner capital asset pricing model. However, cross-sectional asset pricing tests suggest that there are fundamental differences between the Euro Area and the U.S. in this respect. The return on real estate does not add any explanatory power for domestic or foreign asset returns in excess of a stock index return in the U.S. The opposite reasoning applies to the Euro Area. Finally, this paper shows that the distinction between rather global and country-specific pricing factors does not seem to be important for the pricing of excess returns on foreign currencies.

Number of Pages in PDF File: 32

Keywords: CAPM, market risk premium, real estate return, return predictability, foreign currency returns

JEL Classification: G10, G15

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Date posted: August 28, 2008  

Suggested Citation

Nitschka, Thomas, The Risk Premium on the Euro Area Market Portfolio: The Role of Real Estate (August 2008). IEW Working Paper No. 385. Available at SSRN: http://ssrn.com/abstract=1260202 or http://dx.doi.org/10.2139/ssrn.1260202

Contact Information

Thomas Nitschka (Contact Author)
Swiss National Bank ( email )
Börsenstrasse 15
Zurich, CH-8022
HOME PAGE: http://sites.google.com/site/tnitschka/
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