Assessing the Structural Fundamentals of Realized Risk Premiums

Abstract

In investment-decision-making, it is customary to define economic regimes of high or low realized risk premiums with economic indicators such as inflation and growth. We generalize this discrete categorization to a continuous one by estimating a linear relation between economic fundamentals and realized standard and alternative risk premiums. Using a bootstrap method, we estimate that changes in macroeconomic indicators explain about 50% of the variation in realized risk premiums. We apply our estimates to comment on the implication of a prolonged low growth scenario on the prospective level of risk premiums.