Have Risk Premia Vanished?

67 Pages Posted: 6 Jan 2021 Last revised: 3 May 2021

See all articles by Simon Smith

Simon Smith

Board of Governors of the Federal Reserve System

Allan Timmermann

UCSD ; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: November 10, 2020

Abstract

We apply a new methodology for identifying pervasive and discrete changes (``breaks'') in cross-sectional risk premia and find empirical evidence that these are economically important for understanding returns on US stocks. Size and value risk premia have fallen off to the point where they are insignificantly different from zero at the end of the sample. The market risk premium has also declined systematically over time but remains significant and positive as does the momentum risk premium. We construct a new instability risk factor from cross-sectional differences in individual stocks' exposure to time-varying risk premia and show that this factor earns a premium comparable to that of commonly used risk factors. Using industry- and characteristics-sorted portfolios, we show that some breaks to the return premium process are broad-based, affecting all stocks regardless of industry- or firm characteristics, while others are limited to stocks with specific style characteristics. Moreover, we identify distinct lead-lag patterns in how breaks to the risk premium process impact stocks in different industries and with different style characteristics.

Keywords: Cross-sectional variation in risk premia, instability risk factor, industry and style portfolios, Bayesian analysis

JEL Classification: G10, C11, C15

Suggested Citation

Smith, Simon and Timmermann, Allan, Have Risk Premia Vanished? (November 10, 2020). Available at SSRN: https://ssrn.com/abstract=3728192 or http://dx.doi.org/10.2139/ssrn.3728192

Simon Smith (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Allan Timmermann

UCSD ( email )

9500 Gilman Drive
La Jolla, CA 92093-0553
United States
858-534-0894 (Phone)

HOME PAGE: http://rady.ucsd.edu/people/faculty/timmermann/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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