Recovering the Market Risk Premium from Higher-Order Moment Risks

Abstract

We propose a consistent approach for the estimation of the
market risk premium. As a first step, we define the broadest possible set of
ex ante estimators from the viewpoint of a power utility optimizer holding the
market portfolio. We then employ an evaluation framework to optimize the
parametrization of the methodology. We show that this theoretical framework
can still produce reasonable market risk premium estimates, even when the
representative agent is not a power utility optimizer. Our results show that
the inclusion of higher-order moment risk premia improves the accuracy of the method.

Keywords: Ex ante market risk premium; risk aversion coefficient; physical cumulants; risk-neutral cumulants

JEL Classification: G12, G17, C51, C53