Risk_Premium_201

Perhaps the most important confusion we want to clear up is that the level of risk premiums (called term premium in bond markets) has almost no predictive value for short, medium or even long term asset returns. The level doesn’t much matter at all for trading markets. What matters a great deal is drivers for changes in risk premium.

We see three major questions an investor needs to consider.

1. Should they prefer long term assets or cash (Money Market Funds or Tbills)?




2. Should they prefer stocks to bonds when allocating to assets?




3. Should they prefer nominal or real future cash flows when allocating to assets?

Question 1 is answered by determining the direction (not the level) of risk

So what we do is recognize that the levels of risk premium, growth expectations, and inflation expectations are unknowable AND more importantly if known they are not useful to begin with as they are coincident valuation metrics. None of these factors are predictive of future returns.

Our Framework posits that all asset classes are driven by common factors • Changes in Growth Expectations • Changes in Inflation Expectations • Changes in Risk Premiums • Flow and positioning • Idiosyncratic risk within an asset class or across countries

The last voice we greatly respect suggests that the US Treasury curve has a negative risk premium. He believes the risk free rate is better ascribed to a different pool of assets specifically government guaranteed mortgage bonds.

We can absolutely appreciate that idea while not fully agreeing. The implication is the treasury curve offers a lower tha

Perhaps the most important confusion we want to clear up is that the level of risk premiums (called term premium in bond markets) has almost no predictive value for short, medium or even long term asset returns. The level doesn’t much matter at all for trading markets. What matters a great deal is drivers for changes in risk premium.

Said another wa

Unfortunately we are unwilling to give our indicators away. However we are happy to share some key inputs into our work • Expected volatility of each Asset • Correlation expectations • Asset supply and demand across all cohorts • Central bank actions • Fiscal actions • Private sector leverage • Asset performance and investor “pain” • Health of leve