"Subjective Risk Premia in Bond and FX Markets"

Abstract: This paper elicits subjective risk premia from an international survey dataset on interest rates and exchange rates. Survey-implied risk premia are (i) unconditionally negative for bonds, positive for investment currencies and negative for funding currencies, (ii) correlated with (subjective) macro expectations, (iii) correlated with quantities of risk, (iv) meanreverting, as opposed to extrapolative; and (v) predict future realised returns with a positive sign. Deriving a subjective belief decomposition, we exploit surveys to estimate a multicountry asset pricing model with time-variation in economic uncertainty and three probability measures: the risk-adjusted, the physical and a subjective measure. The estimation quantifies the size of financial market belief distortions and demonstrates that subjective risk premia are well explained by a classical risk-return trade-off.

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