Dynamics of subjective risk premia

Abstract

We examine subjective risk premia implied by return expectations of individual investors and professionals for portfolios of stocks, bonds, currencies, and commodity futures. While in-sample predictive regressions with realized excess returns suggest that objective risk premia vary countercyclically with business-cycle and asset-valuation measures, subjective risk premia extracted from survey data are largely acyclical. Out-of-sample forecasts of excess returns exhibit a similar lack of cyclicality, which suggests that investors’ learning of forecasting relationships in real time may help explain the cyclicality gap. There is a subjective risk-return tradeoff, with subjective risk premia increasing in subjective perceptions of risk quantity.