14. Market Risk Premium: Consumption Models Economists have attempted to estimate what the market risk premium should be using consumption based models. Their conclusion is that the historic risk premium is higher than it should be, That’s a “puzzle” The 2007-2008 might have solved the puzzle – risk is higher and returns are lower when we include these years!
15. Equity Risk Premium: Consumption Models Economists sometimes call this the equity risk premium and it’s the same thing. Regardless of what you call it, it’s still a “puzzle”
16. The Relation between Return and Risk Another name for the equity risk premium is “the market price of risk.”
19. A Bit More Math: Excess Return: Return higher than the risk free rate. Slope: Increased in return for an increase in risk L : leverage. : the annualized volatility S : skewness of returns. K : kurtosis of returns