A New Formula for the Expected Excess Return of the Market
54 Pages Posted: 15 Oct 2019 Last revised: 27 Aug 2020
Date Written: September 1, 2019
Key to deriving the lower bound to the expected excess return of the market in Martin (2017) is the assumption of the negative correlation condition (NCC). We improve on the lower bound characterization by proposing an exact formula for the conditional expected excess return of the market. In our formula, each risk-neutral return central moment contributes to the expected excess return and is representable in terms of known option prices. To interpret theoretical and empirical distinctions between our formula and the lower bound, we develop and study the asset-pricing restrictions of the NCC.
Keywords: expected excess return of the market, negative correlation condition, lower bound, market risk premium
JEL Classification: G11, G12, G13
Suggested Citation: Suggested Citation