Asset Pricing Models and Economic Risk Premia: A Decomposition

43 Pages Posted: 6 Mar 2008 Last revised: 10 Sep 2009

See all articles by Pierluigi Balduzzi

Pierluigi Balduzzi

Boston College - Carroll School of Management

Cesare Robotti

Warwick Business School

Multiple version iconThere are 4 versions of this paper

Date Written: September 8, 2009

Abstract

The risk premia of linear factor models on economic (non-traded) risk factors can be decomposed into: i) the premium on maximum-correlation portfolios mimicking the factors; ii) (minus) the covariance between the non-traded components of the pricing kernel and the factors; and iii) (minus) the mispricing of the maximum-correlation portfolios. For a given set of assets available for investment, the first component is the same across models and is typically estimated with little bias and high precision. We conclude that the premia on maximum-correlation portfolios are appealing alternatives to the risk premia of linear factor models, with the dividend yield being the only economic factor significantly priced.

Keywords: economic factors, risk premia, pricing kernel, maximum-correlation portfolio

JEL Classification: G12

Suggested Citation

Balduzzi, Pierluigi and Robotti, Cesare, Asset Pricing Models and Economic Risk Premia: A Decomposition (September 8, 2009). Journal of Empirical Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1102671 or http://dx.doi.org/10.2139/ssrn.1102671

Pierluigi Balduzzi

Boston College - Carroll School of Management ( email )

Department of Finance
140 Commonwealth Avenue - Fulton Hall 438
Chestnut Hill, MA 02467
United States
617-552-3976 (Phone)
617-552-0431 (Fax)

HOME PAGE: http://www.bc.edu/bc_org/avp/csom/faculty/

Cesare Robotti (Contact Author)

Warwick Business School ( email )

West Midlands, CV4 7AL
United Kingdom

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