Risk premium

[wrongsaidfred]

Hi David,

Referring to the CAPM: I read something that referred to Beta*(Equity risk premium) as the asset's risk premium. Is this correct?

Thanks,
Mike

 

[David Harper CFA FRM]

Hi Mike,

I don't have a problem with that. Our readings tend to parse the product into the two components; i.e., excess return = (beta: i.e., "the exposure or sensitivity to...") * (ERP or MRP: "... the common [systematic] risk factor").
Or, excess return = quantity of (systemic) risk * price of (systemic) risk.

In part because, setting aside the theory differences, we tend to view CAPM (superficially, for the purists!) as a special case of APT or multi-factor model, where:
return or excess return = [i.e., is a linear combination of a set of] = (sensitivity1; aka, factor loading * common factor1; aka, factor return1) + (sensitivity2 * common factor2) + ...

For us, in risk, the parsing is meaningful; e.g., factors are external in the market ... some parse the beta*ERP term as, equivalently, (excess market return/variance[market]) * covariance[security, market], and in the same way, that first term is a "feature" of the market's price of risk and the second concerns the security's exposure to it.

I hope that helps, thanks, David