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The Missing Risk Premium: Why Low Volatility Investing Works Paperback – August 16, 2012

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Editorial Reviews


"In this contrarian view of the asset pricing model, Falkenstein attempts to debunk the notion that greater risk equals greater reward...The author's conclusion is likely to be controversial in some circles, if not downright inflammatory" - Kirkus

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Product Details

  • Paperback: 196 pages
  • Publisher: CreateSpace Independent Publishing Platform; 1st edition (August 16, 2012)
  • Language: English
  • ISBN-10: 1470110970
  • ISBN-13: 978-1470110970
  • Product Dimensions: 6 x 0.4 x 9 inches
  • Shipping Weight: 12.5 ounces (View shipping rates and policies)
  • Average Customer Review: 4.2 out of 5 stars  See all reviews (20 customer reviews)
  • Amazon Best Sellers Rank: #719,607 in Books (See Top 100 in Books)

More About the Author

Eric Falkenstein received his economics PhD from Northwestern in 1994, and wrote his dissertation on the low return to high volatility stocks. He set up a Value-at-Risk system for trading operations at KeyCorp, then a firm-wide economic risk capital allocation methodology. He created RiskCalc(TM), Moody's private firm default probability model, the most popular private firm default model in the world. He has been an equity portfolio manager, and currently works on trading algorithms for Walleye Software. Eric has been published in several journals, including the Journal of Finance, The Journal of Fixed Income, Derivatives Quarterly, and others. He blogs at, and has published papers at He lives in the Minneapolis area with his wife and three children.

Customer Reviews

Most Helpful Customer Reviews

53 of 55 people found the following review helpful By Aaron C. Brown TOP 1000 REVIEWERVINE VOICE on September 8, 2012
Format: Paperback
Over the last 60 years, the concept of risk premium has embedded itself so deeply in finance that it is hard to think of investing without relying upon it. It's important to separate this idea from merely keeping expected value constant. If a risk-free bond pays 5 percent interest, a bond that might default must pay more than 5 percent just to have the same expected return. So the fact that junk bonds pay higher yields than investment grade bonds does not prove that there is a risk premium. We would need to show that portfolios of junk bonds had higher long-term average returns than portfolios of investment grade bonds, after subtracting out losses from default.

Falkenstein argues that there is no risk premium, and never was, so conventional investing advice is misguided. He has developed a consistent and plausible alternative explanation. This is a valuable argument, even if it is ultimately not correct. You cannot understand risk premium if you think it is obvious, you need to see why it might not exist to see how to look for it.

The book also describes an investment approach, a version of what is generally called low-volatility investing. The author is among the pioneers in this area and he advocates a reasonable version of it.

When I reviewed the author's first book, Finding Alpha, I complained about the $95 list price and suggested it should be $25 list to sell for $15 at Amazon. I don't know if he was paying attention, but if he was, he traded through my bid by a nickel. Unfortunately he didn't listen to my complaints about the copy editing and production values.
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28 of 30 people found the following review helpful By Dimitri Shvorob on November 4, 2012
Format: Paperback
The complaints will take more space, so I want to emphasize the praise. This is an original, highly informative, thought-provoking book. Do check it out.

I would group the book's chapters as follows:

* Chapters 2-3 (24 pages), which discuss economists' work on modeling asset risk and return.
* Chapter 4 (53p), which points to poor returns for a number of risky assets and investment strategies.
* Chapter 7 (12p), which surveys common rationalizations of findings similar to those of Chapter 4.
* Chapters 5, 6, 8 (36p), which advance the alternative of modeling investors as caring about their wealth *relative to others*.
* Chapter 9 (8p), which sets out the author's investing approach.

The book's title, "The missing risk premium: why low-volatility investing works", is confusing. Falkenstein's "low-volatility investing" means, on different pages, either avoidance of high-volatility stocks, or selection of the minimum-volatility portfolio in a Markowitz problem (not so contrarian after all), or a combination of both. If it works, it isn't because of a missing risk premium, as neither the deceased straw man of CAPM (whose introduction in Chapter 2 omits a list of assumptions, which most textbooks feel obliged to state and discuss), nor its multifactor nephews, posit a risk premium for total volatility in the first place.

Underperformance of a priori "risky" assets (if conclusively shown) does not immediately imply a negative risk premium, if systematic expectational errors - or, trivially, risk-loving preferences, if we choose to remain in the rational-expected-utility-maximizer framework - have not been ruled out.
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5 of 6 people found the following review helpful By investingbythebooks on January 12, 2013
Format: Paperback
A risk premium could be defined as a situation where an investor receives a higher expected return as a compensation for taking higher risk. The overarching thesis of the author is that positive risk premiums are extremely rare. Eric Falkenstein was one of the first to research the low volatility anomaly and he is today a quantitate portfolio manager of, surprise, a low volatility equity portfolio and he has both theoretically and practically shown that the returns from low risk shares historically has been higher than the market in general and substantially higher than high risk shares that have had horrendous returns. This is valid irrespective of whether risk is measured with beta, volatility, profit margins, leverage etc.

In the chapter that makes up the bulk of the book Falkenstein reviews 25 different assets and in all but in a few cases there is either no correlation between higher risk taking and expected returns or the correlation is actually negative. There simply is no such thing as a "linear courage premium". Only in a handful of cases is exposure to a higher level of risk rewarded by higher returns. The positive risk premiums are a) short end yield curve, b) BBB-AAA corporate spread, c) REITs and d) gross equity return. The reason for the "gross" in equity returns is that Falkenstein argues that the actual returns the average equity investor historically has received after taxes, poor market timing, transaction costs and geometric averaging are close to the risk free rate.

The reason that positive risk premiums are so rare is, according to Falkenstein, that humans are more motivated by envy than by greed, that is they are more interested in their relative than in their absolute position.
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