RISK PREMIA AND VARIANCE BOUNDS

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-vari ance 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 sever ity of the ''equity-premium puzzle'' of Mehra and Prescott (1985).