US risk premia under emerging markets constraints

Abstract

The US equity market is the benchmark for empirical finance and considered the closest example of how an efficient market should behave. On the other hand, divergent results from those observed in the USA are often associated with unreliable and deviations from the efficient market hypothesis. However, how would the US market results behave had the data the same constraints as an emerging market economy? To answer that question, we analyze the market risk premia under typical constraints from emerging equity markets, such as the small number of assets and the short time-series sample available for estimation. We use parameters of time-series length, number of assets, and accounting variables distribution from the Brazilian equity market as an empirical application of our methodology. Surprisingly, we conclude that the US market risk premia convey the same data features as the Brazilian risk premia had they the same time constraints. Then, we evaluate two potential causes of problems in risk premia estimations with small T : (i) small sample bias on betas, and (ii) divergence between ex-post and ex-ante risk premia. Through Monte Carlo simulations, we conclude that for the T around five years, the beta estimates are no longer a problem in terms of premium significance. However, it is necessary to analyze a time-series sample exceeding 40 years to obtain robust and reliable ex-ante risk premia. • The US and emerging market economies risk premia behave the same when they are estimated with the same time constraints. • For robust and reliable ex-ante risk premia estimation, it is necessary to analyze a time-series sample exceeding 40 years. • Estimated betas with five-year time series are reliable.