Abstract

This paper offers a novel framework for understanding the equilibrium price of risk. Notably, it illustrates the CAPM fails under its own exact assumptions when the fair price of total risk is not (ex ante) linear. A linear Security Market Line then nevertheless remains, yet consistent with empirical findings with an intercept distinct from the (proxy for the) risk free rate. The framework may also resolve the equity premium puzzle and it debates the notion of pricing marginal values only. Also, a consensus price of total risk results in an informational efficiency (only), bridging market efficiency and behavioral finance.

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