(whentheeconomyisdoingwell,investorstendtobemuch
more willing to take risk) and recent experiences in the
market (risk premiums tend to surge after large market drops).
2.Riskinessoftheaverage-riskinvestment.Astheperceived
riskinessoftheaverage-riskinvestmentincreases,soshould
thepremium.Thekey,though,isthatwhatinvestorsperceive
to be the average-risk investment can change over time,
causing the risk premium to change with it.
Sinceeachinvestorinamarketislikelytohaveadifferent
assessmentofanacceptablepremium,thepremiumwillbea
weighted average ofthese individualpremiums, where the
weightswillbebasedonthewealththeinvestorbringstothe
market. In thearbitrage pricing model and themultifactor
models, the risk premiums used for individual factors are
similar wealth-weighted averages of the premiums that
individual investors would demand for each factor separately.
Estimating Risk Premiums
Therearethreewaysofestimatingtheriskpremiuminthe
capitalassetpricingmodel:Largeinvestorscanbesurveyed
abouttheirexpectationsforthefuture,theactualpremiums
earnedoverapastperiodcanbeobtainedfromhistoricaldata,
and the implied premium can be extracted from current
market data. The premium can be estimated only from
historical data in the arbitrage pricing model and the
multifactor models.
Survey Premiums