34 Pages Posted: 2 Apr 2007 Last revised: 12 Dec 2014
Date Written: February 28, 2007
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: Suggested Citation