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Implications for Asset Pricing Puzzles of a Roll-over Assumption for the Risk-Free Asset


  • *This paper arises from the author's doctorate, which was completed at the Australian Graduate School of Management at the University of NSW. The author benefited from some valuable comments, suggestions and encouragement from Chris Adam, Nicholas Bollen, Doug Foster, Lorenzo Garlappi, Shayne Gary, Bruce Grundy, Ron Guido, Richard Heaney, Terry O'Neill, Baljit Sidhu, Tom Rietz, Tom Smith, Garry Twite, and Kathy Walsh. The author also wishes to thank participants at the 2005 AFAANZ Conference and the 16th Asian Financial Association Conference, as well as FIRN for financial support to attend the latter.

Geoffrey J. Warren
Senior Research Associate
Russell Investments
GPO Box 3279
NSW, 2001


The equity risk premium and risk-free rate puzzles are largely resolved by combining persistent uncertainty over the long-term consumption growth rate with analysis of the risk-free asset on a ‘roll-over’ basis. Under these conditions, cash equivalents are evaluated as a multi-period investment strategy that hedges against adverse growth rate outcomes. The premium on the risky asset is raised and the risk-free rate lowered due to their respective relation with multi-period consumption risk. Historical average asset returns are matched at plausible risk aversion.