Validity, Tightness, and Forecasting Power of Risk Premium Bounds

Recent work uses option prices to derive lower bounds for the risk premia of the market portfolio and individual stocks. We test the bounds conditionally. We cannot reject that they are valid, but we do reject that they are tight. Using the market bounds as forecasts appears unreasonable in many cases due to their high slackness. Adding past mean slackness is a potential improvement but is hampered by the brevity of the available data series. The correlation of the stock bounds with subsequent returns stems primarily from the time series rather than the cross section.

Keywords: Risk premia, bounds, conditional tests, predictability

JEL Classification: G12, G13, G14

Suggested Citation: Suggested Citation

Back, Kerry and Crotty, Kevin and Kazempour, Seyed Mohammad, Validity, Tightness, and Forecasting Power of Risk Premium Bounds (October 2, 2020). Available at SSRN: https://ssrn.com/abstract=3704908 or http://dx.doi.org/10.2139/ssrn.3704908