On the Concavity of Jump Equity Premia

Abstract

The inherent incompleteness of continuous-time economies driven by market microstructure noise (modeled here as a Levy process) forces agents to price assets in new ways that have no analog in the dynamically complete continuous-path markets driven by a diffusion. It is shown that microstructure risk premia are non-linear functions of beta. The novel insight, counter to intuition, is that risk premia for stocks exposed to any type of negative Levy jumps are a concave function of their beta.

Keywords: Risk premia, Jump premia, Levy processes

JEL Classification: G12, G13