Dynamics of Subjective Risk Premia

We examine subjective risk premia implied by return expectations of individual investors and professionals for aggregate 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 variables and aggregate asset valuation measures, we find subjective risk premia extracted from survey data do not comove much with these variables. This lack of cyclicality of subjective risk premia is a pervasive property that holds in expectations of different groups of market participants and in different asset classes. A similar lack of cyclicality appears in out-ofsample forecasts of excess returns, which suggests that investors’ learning of forecasting relationships in real time may explain much of the cyclicality gap. These findings cast doubt on models that explain time-varying objective risk premia inferred from in-sample regressions with countercyclical variation in perceived risk or risk aversion. We further find a link between subjective perceptions of risk and subjective risk premia, which points toward a positive risk-return tradeoff in subjective beliefs. We are grateful for comments and suggestions to Ching-Tse Chen, Ken French, Niels Gormsen, Ian Martin, Monika Piazzesi, seminar participants at Boston College, University of Utah, and conference participants at NBER Behavioral Finance Meeting. University of Chicago, Booth School of Business, 5807 South Woodlawn Avenue, Chicago, IL 60637, e-mail: [email protected] City University of Hong Kong, Department of Economics and Finance, 83 Tat Chee Avenue, Kowloon, Hong Kong, e-mail: [email protected]