What question did this study set out to answer?

The study aims to derive a new variance bound for pricing kernels and examine its implications for consumption risk premiums.

December 1, 1997

Risk Premia and Variance Bounds

Key Points

The study aims to derive a new variance bound for pricing kernels and examine its implications for consumption risk premiums.
Deriving a variance bound that is stricter than previous models by Hansen and Jagannathan.
Applying the new variance bound to the pricing kernel of a consumer with power utility.
The derived variance bound indicates that the pricing kernel exhibits greater variability than the minimum-variance kernel.
The consumption risk premium amplifies the equity-premium puzzle identified by Mehra and Prescott.

Abstract

ABSTRACT If a pricing kernel assigns a premium to a risk variable that differs from the one assigned by the minimum‐variance admissible kernel, then the pricing kernel must exhibit more variability than the minimum‐variance kernel. Based on this intuition, we derive a variance bound that is more stringent than that of Hansen and Jagannathan (1991) . When we apply our bound to the kernel of a representative consumer with power utility, we find that the consumption risk premium increases the severity of the “equity‐premium puzzle” of Mehra and Prescott (1985) .

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