Boundedly rational equilibrium and risk premium

This paper aims to analyse the impact of behavioural biases on asset pricing by hypothesising that sentiment and momentum are relevant risk factors in Pakistan equity market. The paper also examines the influence of sentiment and momentum factors on market risk, size, and value premiums by estimating the interacted asset-pricing model. To carry out the empirical analysis, monthly stock returns of firms listed on Pakistan Stock Exchange are used for the period 2000–2013. The empirical results indicate that both investor sentiment and momentum factors have a significant impact on the required rate of returns. Specifically, it is found that the premium for both factors is positive and statistically significant. Further, the estimated results provide evidence that the inclusion of these two factors in the Fama-French three-factor model considerably increases the prediction power of the model. The results also reveal that the inclusion of sentiment factor in the Carhart four-factor model significantly increases the prediction power of the model. Yet, the estimation results indicate that the prediction power of the model further increases when the interaction terms are added to the model in order to examine the indirect effects of sentiment and momentum. The results of the interacted model provide evidence of a significant impact of investor sentiment and momentum factors on market risk, size, and value premiums. Although investor sentiment negatively affects all the three premiums, the effect of momentum is positive for both market risk and size premium, whereas, it is negative for value premium. The findings are helpful in explaining and understanding the effects of behavioural biases on stock returns in Pakistan. The findings of the indirect effects suggest that investor sentiment and momentum factors significantly increase the chance of mispricing in Pakistan equity market.

US risk premia under emerging markets constraints

The purpose of the work is to examine the relationship between market risk premium and default. The research hypothesis assumes that the amount of the market risk premium significantly affects the level of the estimated probability of default of the company. The analysis was carried out using the example of the largest capital markets in the European Union and GFCI within the period from 1 January 2012 to 31 December 2018. Time series of the 20 most important stock market indices of non-financial companies representing all continents were applied in the empirical study. The largest non-financial companies, with regard to assets held as of 1 January 2012, listed on particular capital markets and included in the analyzed stock indices, one for each index, were included in the study. The following research methods were applied: the CAPM equilibrium model, Sharpe’s market asset value ratio and the market value of the corporate equity. The empirical study used time series of the 20 most important stock market indices of non-financial companies representing the analyzed markets. As a result of the analysis, the following research conclusion was established: the final value of companies from the GFCI area does not prove any significant difference with regard to their value before considering the risk premium. In the case of the EU market, this difference is significant. This means that capital markets with weaker capital and poorer, less stable economic conditions are less able to face market risk

This paper develops an intertemporal, international asset pricing model for use in applied theoretical and empirical research. An important feature of the model is that it incorporates both stochastic inflation rates and stochastic Purchasing Power Parity deviations (PPP). The model derives the equilibrium real return on assets, and obtains empirically tractable reduced form equations which can be used to examine such issues as capital market segmentation, currency substitution, exchange rate volatility, and the forward exchange market's risk premium. Mechanically, the model begins as a system of stochastic differential equations which describe the dynamic paths of a vector of state variables, prices, and PPP deviations. The state variables' intertemporal development determines the production and credit opportunities, and provides the model's fundamental dynamic nature. The model is shown to be consistent with the domestic-general equilibrium asset pricing models of Cox, Ingersoll, and Ross (1985) and Brock (1982). The model is applied to pricing forward exchange, and an empirically tractable equation of the risk premium is derived which will allow researchers to uncover the risk premium's economic determinants.

This study investigates the explanatory capacity of macroeconomic variables on the stock market risk premiums of Australia, Germany, Japan, the United Kingdom and the United States of America. The results display that the markets are significantly related to the movements of the world marketplace, and that the incremental explanatory capacity of individual economic factors over this effect is minimal. Several macroeconomic variables are significantly related to market risk premia at differing points in time and on differing economies, although these variables fail to consistently explain risk premia either across markets or across time. The results are consistent with the capital asset pricing model in so far as the world marketplace encompasses the individual stock markets. The results are also consistent with the market integration hypothesis.

ABSTRACTWhile many studies document that the market risk premium is predictable and that betas are not constant, the dividend discount model ignores time‐varying risk premiums and betas. We develop a model to consistently value cashflows with changing risk‐free rates, predictable risk premiums, and conditional betas in the context of a conditional CAPM. Practical valuation is accomplished with an analytic term structure of discount rates, with different discount rates applied to expected cashflows at different horizons. Using constant discount rates can produce large misvaluations, which, in portfolio data, are mostly driven at short horizons by market risk premiums and at long horizons by time variation in risk‐free rates and factor loadings.

Investors having an understanding of investment statistics are important. Especially quantitative tools related to investment risk measurement. Value-at-Risk Adjusted is one of the investment risk measurement tools, which assumes that returns are not normally distributed.This paper intends to measure investment risk based onValue-at-Risk Adjustedor called Modified Value-at-Risk under the Capital Asset Pricing Model. It is assumed that the return of the market index has a non-constant average and there is a long memory effect. The average of the return of the market index is estimated using ARFIMA models.It is also assumed that the stock risk premium correlates with market risk premiums, and stock risk premiums some time before. The correlation will be analyzed using the ARMAX-GARCH model approach. The Modified Value-at-Risk was then formulated based on the Capital asset Pricing Model with the ARMAX-GARCH model approach.To measure the performance of Modified Value-at-Risk that has been formulated is done with back testing. Back testing is carried out based on the Lopez II method. As a case study, analyzed some data on 10 stocks traded on the capital market in Indonesia.The results of the analysis show that the market index return risk premium significantly follows the ARFIMA model, and the 10 share risk premium significantly follows the ARMAX-GARCH model. Based on the results of back testing calculations indicate that the Value-at-Risk Adjustedor Modified Value-at-Risk is very suitable to be used to measure investment risk in the 10 stocks analyzed.

This paper examines whether and how differences in investors' information environments (measured by a country's information disclosure, accounting standards, and financial transparency) are related to cross-country differences in the market risk premium volatility. We use the vector-autoregressive and implied cost of capital methods to extract time variation in risk premiums for 41 developed and emerging markets worldwide. Consistent with theoretical predictions, countries with better information environments tend to experience a lower risk premium volatility, even after controlling for various country variables that are potentially associated with variation in risk premiums. Our analysis of two exogenous events, specifically the 1997 Asian financial crisis and 2008 global financial crisis, further corroborates our key finding that information environments play an important role in explaining market risk premium variability.This paper was accepted by Wei Xiong, finance.

Recent events have highlighted the potential importance of nonlinear efiects of flscal variables (notably debt and deflcits) on interest rates: While in times when government solvency is not a concern the standard crowding-out efiects are of moderate magnitude, in times when default risk becomes an issue the interest rate efiects can become very large. This paper provides new evidence on the magnitude of these efiects. For the case when default risk is not a concern, it uses an arbitrage-free term structure model to estimate the dynamic efiects of flscal policy shocks on interest rates along the entire maturity spectrum. For the case when default risk becomes a concern (thereby violating a central assumption of the term structure model), I present evidence based on EMU government bond spread regressions on time-varying efiects of national flscal policies on spreads as well as the time-varying sensitivity of yield spreads to international risk aversion as a function of the state of flscal policy. JEL classiflcation: E6, H6.

Variance risk in aggregate stock returns and time-varying return predictability

Required Market Risk Premium among countries in 2012

CAPM and Time-Varying Beta: The Cross-Section of Expected Returns

The Risk Premium on the Euro Area Market Portfolio: The Role of Real Estate

Speculation, risk aversion, and risk premiums in the crude oil market

SummaryThe exploration and production (E&P) industry is facing a net-present-value (NPV) paradox. Despite the fact that the NPV method is widely criticized by practitioners and academics alike, the NPV method remains the cornerstone of E&P project valuation. We posit that this contradiction, which we labeled the NPV paradox, is likely to be caused by a combination of limitations of the method, a lack of theoretical understanding, and ambiguity regarding the implementation of the NPV method.Even though the NPV method has been described in numerous papers and textbooks, rigorous and succinct guidance on how to determine risk premiums for systematic risk is not available. We demonstrate that risk-adjusted discount rates are very sensitive to the choice of the length of the periods over which returns are determined (daily, weekly, or monthly), length of the time horizons considered (such as 10 or 25 years), and start date (such as 1965 or 1990). We discuss the fundamental implications and rationale of choices and their effects on the variables that underpin the risk-adjusted discount rate: risk-free rate, company β, market-risk premium, and the cost of debt.Although not entirely satisfactory, we argue for a moderate downward revision of discount rates for projects with timelines exceeding 20 years. This recommendation is dependent on recent advancements in public finance and the reality that the exposure to systematic risk in the long run is significantly less in many real-life E&P projects than the capital-assessment-pricing model (CAPM) implies. The inflated discount rate that is currently used, combined with the extended investment horizons that are common in the upstream sector, will for example result in an underweighting of decommissioning and future legacy costs.In addition to a set of widely recognized shortcomings of the NPV model, there are also lesser well-known issues. For example, the failure of CAPM to capture bankruptcy risk has a bearing on the project-risk premium. Also, the application of the NPV model implies a set of probabilistic assumptions around market risks that are likely to be invalidated when evaluating a set of market scenarios or using a series of probability-weighted market scenarios.