Possible variables explaining the risk premium include:

A) yield curve slope
B) dividend yield
C) bond default premium
D) all of these choices

Question

Possible variables explaining the risk premium include:

A) yield curve slope
B) dividend yield
C) bond default premium
D) all of these choices

Quizplus · Accepted Answer

A number of determinants of the equity market risk premium have been suggested in the literature.Copeland (1982)suggests that the risk premium is affected by the level of uncertainty associated with the inflation rate.It is argued that firms may increase prices with increased inflation rates,and so inflation risk is not as important in pricing equities as it is for pricing bonds.Bonds generally pay fixed cash flows,and so the price of these assets may be more sensitive to inflation uncertainty.This argument provides one explanation for the possibility of ex-ante risk premium being negative,as there is some evidence of negative ex-ante risk premium observed in Boudoukh,Richardson and Smith (1993).French,Schwert and Stambaugh (1987)suggest an alternative explanation,arguing that leverage could also provide an explanation for the observed negative relationship.Research has identified a number of risk premium explanatory variables.These include yield curve slope and the level of stock prices (Keim and Stambaugh 1986),dividend yield (Fama and French 1988)and size premium,book-to-market premium and bond default premium (Fama and French 1993).

Possible Variables Explaining the Risk Premium Include