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An anatomy of global risk premiums


Long-term investors are attuned to the thought that risk is rewarded. By making an investment with more potential variation in returns, investors demand a risk premium – the expected return in excess of a comparatively risk-less investment. This is particularly espoused in the long-term investments of pension funds, yet is a reductive view of financial markets. We investigate the realized risk premiums in a global, multi-asset portfolio of a typical pension fund between 1999–2015, and relate the variation of the realized risk premiums to macroeconomic fluctuations. Owing to the coincident relation between the realized risk premiums and the economic cycle, under the prevailing economic condition, the Sharpe ratios of portfolios constructed ex post to capitalize on risk premiums are appallingly low (between −1 and 0.2). Therefore, despite the heartening corroboration of risk premiums’ existence, investors are susceptible to their time variation.

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  1. 1.

    Other justifications for pension funds to invest in equities include the asset class’ ability to hedge inflation and/or wage risk. This is relevant for indexed pension benefits (Sundaresan and Zapatero, 1997).

  2. 2.

    ' denotes the complex conjugate transpose of the matrix.

  3. 3.

    We adopt an approximate factor model by assuming that F t and e t are uncorrelated, though the asset returns’ idiosyncratic components are allowed to have a limited degree of dynamic cross-correlation. Formally, this means that the matrix comprised of cov(e i , e j ) is not necessarily diagonal, but the largest eigenvalue of the idiosyncratic component’s covariance matrix is bounded. Chamberlain and Rothschild (1983) present the approximate factor structure in detail, outline the conditions that justify its application, and suggest Principal Component Analysis to estimate the factors.

  4. 4.

    For an exposition of PCA applied to financial data, confer Alexander (2001).

  5. 5.

    These include Connor and Korajczyk (1993); Bai and Ng (2002); Onatski (2009); Alessi et al (2010).

  6. 6.

    Boon and Ielpo (2014) consider global equity indices, government bonds, currencies, futures, and commodities.

  7. 7.

    The risk-free rate is the US government three-month Treasury bill.

  8. 8.

    The code implementing Alessi et al (2010) is available at (last visited 11 April 2015).

  9. 9.

    Assuming that the eigenvalues are ordered by magnitude, θ1<θ2<…<θ N . For i=1…N, is the amount of variation explained by the ith PC.

  10. 10.

    For example, volatile investment values are undesirable for a corporate-sponsored defined-benefit fund because the sponsor has to recognize unfunded liabilities on its balance sheet under major accounting regulations. This is a provision under the Financial Accounting Standard (FAS) 158 currently followed by incorporated firms in the United States, and the International Accounting Standards (IAS) 19 adopted by almost all of the rest of the world.

  11. 11.

    In 2015, for instance, 4 out of 10 of the main constituents of the MSCI Emerging Europe Index are Russian energy companies that measures about 20 per cent of the index’s weight) (MSCI Emerging Markets Europe Investable Market Index (IMI) Fact Sheet, 2015).

  12. 12.

    Energy weighs close to 35 per cent of the Bloomberg Commodity Index (Bloomberg Commodity Index Fact Sheet. 31 August 2015).

  13. 13.

    The eigenvector scaling to restrict the standard deviation of the factor portfolio returns to be less than 10 per cent applies to the entire sample period. This does not rule out the possibility that within the sample period, the standard deviation exceeds 10 per cent.

  14. 14.

    Majority of the countries covered by the indices that constitute the portfolio are members of the Organization for Economic OECD.

  15. 15.

    In contrast, real consumption growth is known to be smooth. In the United States, for instance, annualized standard deviation for seasonally adjusted real consumption growth in the 1980s–1990s is 1.1 per cent (Campbell, 2003).


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The authors would like to thank Douglas Breeden, Marielle de Jong and an anonymous reviewer of the journal for their suggestions. The views and opinions expressed herein do not necessarily state or reflect those of Amundi or Unigestion.

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Correspondence to Ling-Ni Boon.

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Boon, LN., Ielpo, F. An anatomy of global risk premiums. J Asset Manag 17, 229–243 (2016).

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  • sharpe ratio
  • risk premium
  • long-term investing