Wednesday, September 1, 2010

Unstable risk premiums: A new paper

I am back from a long hiatus from posting, but I had nothing profound (even mildly so) to post and I was on vacation for a couple of weeks and Latin America last week.

As many of you have read in my postings, I am working on a book where I look at shaking up some of the fundamental assumptions that underlie modern finance. My first chapter on "what if nothing is risk free?" was posted about four weeks ago and you can still get to it by going to:
My second chapter builds on a theme that has been a bit of an obsession for me on risk premiums and how they have become more unstable, unpredictable and linked across markets. The paper titled,
A New Risky World Order: Unstable Risk Premiums - Implications for Practice, is now ready to download and you can get to it by clicking on the link below.

The paper is long (about 60 pages) but hopefully not verbose. A great deal of what I say in the paper, I have said before in my papers and posts on equity risk premiums. The difference in this paper is two fold.
  1. I expand my analysis to look at risk premiums in different markets - default spreads in bond markets and real asset premiums in real asset markets. In the process, I can examine how risk premiums in different markets have begun more moving together and how divergences across markets can be used to fine tune both investment and corporate financial decisions.
  2. I do present a template that can be used by practitioners to choose between the bewildering array of risk premium estimates that are out there. When should you use a current premium and when should you use a historical premium?

I am working on my third chapter of the book: What if nothing is liquid?, where I hope to look at what would happen to valuation and corporate finance practice, if markets essentially shut down. I hope I will have something interesting to say.

1 comment:

Rajiv said...

Dear Prof Damodaran

Thank you for your thoughtful views on the subject and eagerly awaiting your response on chapter 3 of your book.
I was having some discussion with other CFA friends on a related topic and it might interest you for getting some minor inputs for your chapter 3. Though, I do beleive that you would have your own crystal clear thoughts, but may be spending 5-10 minutes to go through some other opinions may not be simply a waste of time!