Macro/Micro Foundations of Risk Premiums
Preview:
In the previous posts, we introduced the concept of risk-neutral pricing:
The Feynman-Kac theorem asserts that the solutions to risk-neutrally priced assets satisfy the BSM PDE by drawing the link between SDE and PDEs. These were discussed:
These arguments were largely theoretical - one may be left somewhat confused about why the change of measure, or the divergence of probability measures exist in the first place. What does ‘risk-neutral’ even suggest? The concept of risk premiums and consumption volatility ties together these ideas based on the underlying behavior of investor activity.
Risk Premiums (paper, 9 pages):
Full Market Notes: (326 + 29 Pages) - paid readers: