Implied Economic Risk Premiums
E. J. Ourso College of Business, Louisiana State University
July 26, 2013
The literature on economic risk premiums has largely been based on ex post returns. I construct and assess implied ex ante economic risk premiums for a list of economic factors, which are driving forces in various asset pricing models, using direct expected returns estimates --- i.e., the implied costs of capital (ICCs). For most economic factors, ICCs support significant nonzero average economic risk premiums which ex post returns fail to uncover since ex post returns are so volatile, implying that many economic factors are actually priced from an ex ante perspective. The implied ex ante factor risk premiums are powerful predictors for the future ex post returns of factor mimicking portfolios for most 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 strongly suggested by the ICC-based risk premiums.
Number of Pages in PDF File: 79
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, G14working papers series
Date posted: July 30, 2013
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