Risk Premia and Variance Bounds




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    • Balduzzi is from the Carroll School of Management, Boston College. Kallal is from Salomon Brothers. We thank Giorgio De Santis, John Heaton, Silverio Foresi, Ravi Jagannathan, Peter Knez, Anthony Lynch, Margaret McMillan, Ken Singleton, René Stulz, two anonymous referees, and seminar participants at the 1996 Winter Meetings of the Econometric Society, the 1996 Colloquia on Economic Research (IGIER, Milan), the 1996 Meetings of the Western Finance Association, and the 1997 Utah Winter Finance Conference for useful comments. We acknowledge financial support from New York University Summer Research Grants. This research was initiated while the authors were affiliated with New York University. Salomon is not responsible for any statement or conclusions herein, and no opinions, theories, or techniques presented herein in any way represent the position of Salomon Brothers, Inc.


If a pricing kernel assigns a premium to a risk variable that differs from the one assigned by the minimum-variance admissible kernel, then the pricing kernel must exhibit more variability than the minimum-variance kernel. Based on this intuition, we derive a variance bound that is more stringent than that of Hansen and Jagannathan (1991). When we apply our bound to the kernel of a representative consumer with power utility, we find that the consumption risk premium increases the severity of the “equity-premium puzzle” of Mehra and Prescott (1985).