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Why Risk is Not Related to Return

34 Pages Posted: 2 Apr 2007 Last revised: 12 Dec 2014

Eric G. Falkenstein

Pine River Capital Management

Date Written: February 28, 2007

Abstract

This paper argues that in general risk is not empirically correlated with returns in any obvious way. This puzzle is explained as the implication of a utility function in which if people care only about relative wealth, risk is a deviation from what everyone else is doing, and therefore becomes avoidable and unpriced, similar to diversifiable risk in the Capital Asset Pricing Model (CAPM). Using a utility or arbitrage argument, a relative status utility function creates a zero risk-return correlation via a market model that implies a zero risk premium, and has other applications.

Keywords: risk premium, CAPM, relative status

JEL Classification: D01, D81, G11, G12

Suggested Citation

Falkenstein, Eric G., Why Risk is Not Related to Return (February 28, 2007). Available at SSRN: https://ssrn.com/abstract=976652 or http://dx.doi.org/10.2139/ssrn.976652

Eric G. Falkenstein (Contact Author)

Pine River Capital Management ( email )

601 Calson Parkway, Suite 330
Minnetonka, MN 55347
United States
6123091588 (Phone)
6123091588 (Fax)

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