Implied Economic Risk Premiums
E. J. Ourso College of Business, Louisiana State University
February 13, 2014
The literature on economic risk premiums has largely been based on ex post returns. I construct implied ex ante risk premiums for a list of economic factors, using direct expected returns estimates --- i.e., the implied costs of capital (ICCs). For most factors, ICCs support significant nonzero average economic risk premiums which ex post returns fail to uncover, implying many factors are actually priced from an ex ante perspective. The implied factor risk premiums are powerful predictors for the future ex post returns of mimicking portfolios for many economic factors (e.g., value and size factors, default spread, inflation, the growth rate of labor income, and one-month T-bill real return), both in sample and out of sample. Time-varying ex ante economic risk premiums are significantly suggested by ICCs.
Keywords: economic risk premiums, factor risk premiums, implied costs of capital, factor mimicking portfolios, factor pricing, time-series predictability, ex ante perspective, time-variant risk premiums
JEL Classification: G12, G14
Date posted: July 30, 2013 ; Last revised: November 14, 2015
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