Risk Premium Bounds: Slackness Tests and Return Predictions

84 Pages Posted: 21 Nov 2020

See all articles by Kerry Back

Kerry Back

Rice University - Jesse H. Jones Graduate School of Business

Kevin Crotty

Rice University - Jesse H. Jones Graduate School of Business

Seyed Mohammad Kazempour

Rice University - Jesse H. Jones Graduate School of Business

Date Written: October 2, 2020

Abstract

Martin (2017) and subsequent authors derive lower bounds for risk premia on the market portfolio and for individual stocks using option prices. If the bounds are tight and the options market is informationally efficient, then the bounds must be the best possible predictors of returns. We test the bounds conditionally and find that they are valid in all market conditions but are not tight in all market conditions. Slackness is significant and predictable. Adding predicted slackness to a bound produces a return predictor that is superior to using the bound alone.

Keywords: Risk premia, bounds, conditional tests, predictability

JEL Classification: G12, G13, G14

Suggested Citation

Back, Kerry and Crotty, Kevin and Kazempour, Seyed Mohammad, Risk Premium Bounds: Slackness Tests and Return Predictions (October 2, 2020). Available at SSRN: https://ssrn.com/abstract=3704908 or http://dx.doi.org/10.2139/ssrn.3704908

Kerry Back

Rice University - Jesse H. Jones Graduate School of Business ( email )

6100 South Main Street
P.O. Box 1892
Houston, TX 77005-1892
United States

Kevin Crotty (Contact Author)

Rice University - Jesse H. Jones Graduate School of Business ( email )

6100 Main Street
Houston, TX 77005-1892
United States

Seyed Mohammad Kazempour

Rice University - Jesse H. Jones Graduate School of Business ( email )

6100 South Main Street
P.O. Box 1892
Houston, TX 77005-1892
United States

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