THE VALUATION OF NONSYSTEMATIC RISKS AND THE PRICING OF SWEDISH LOTTERY BONDS

Swedish government lottery bonds have coupon payments determined by lo ttery. They offer a unique opportunity to study a security with uncert ain payoffs having a known, observable distribution. The risk associat ed with the lotteries is idiosyncratic by construction and should not command a risk premium in equilibrium. The bonds are traded in two for ms, allowing us to evaluate the rewards to bearing extra lottery risk. Despite its idiosyncratic nature, we find prices appear to reflect av ersion to this risk. We evaluate the empirical determinants of this di fferential pricing and possible explanations for it.