{"id":19112,"date":"2021-08-04T14:57:39","date_gmt":"2021-08-04T14:57:39","guid":{"rendered":"https:\/\/analystprep.com\/study-notes\/?p=19112"},"modified":"2026-06-29T19:00:23","modified_gmt":"2026-06-29T19:00:23","slug":"explain-the-relationship-between-the-consumption-hedging-properties-of-equity-and-the-equity-risk-premium","status":"publish","type":"post","link":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/explain-the-relationship-between-the-consumption-hedging-properties-of-equity-and-the-equity-risk-premium\/","title":{"rendered":"Equity and Equity Risk Premium"},"content":{"rendered":"\r\n<script type=\"application\/ld+json\">\r\n{\r\n  \"@context\": \"https:\/\/schema.org\",\r\n  \"@type\": \"QAPage\",\r\n  \"mainEntity\": {\r\n    \"@type\": \"Question\",\r\n    \"name\": \"Which of the following statements about equity is the least accurate?\",\r\n    \"answerCount\": 3,\r\n    \"acceptedAnswer\": {\r\n      \"@type\": \"Answer\",\r\n      \"text\": \"The correct answer is C. The consumption hedging property highlights that the payoff of a security during good economic times is what matters more than its return. This statement is incorrect because the consumption hedging property emphasizes the value of assets that provide higher payoffs during bad economic times, when consumption is low. Such assets help hedge consumption risk and therefore command lower risk premiums.\"\r\n    },\r\n    \"suggestedAnswer\": [\r\n      {\r\n        \"@type\": \"Answer\",\r\n        \"text\": \"Equity provides a poor hedge against bad consumption outcomes.\"\r\n      },\r\n      {\r\n        \"@type\": \"Answer\",\r\n        \"text\": \"Assets that provide a higher payoff during economic downturns have lower risk premiums.\"\r\n      },\r\n      {\r\n        \"@type\": \"Answer\",\r\n        \"text\": \"The consumption hedging property highlights that the payoff of a security during good economic times is what matters more than its return.\"\r\n      }\r\n    ]\r\n  }\r\n}\r\n<\/script>\r\n\r\n<p><iframe loading=\"lazy\" src=\"\/\/www.youtube.com\/embed\/NFyA0qXHhww\" width=\"611\" height=\"343\" allowfullscreen=\"allowfullscreen\"><\/iframe><\/p>\r\n<p>Equity refers to a security with an indefinite size and timing of dividends. Moreover, these dividends may stop in the event of bankruptcy. This makes equities riskier than debt. Equities, therefore, require an additional risk premium.<\/p>\r\n<p>More precisely, investors who invest in equities require a return given by:<\/p>\r\n<p>$$ \\left(R+\\theta_t+\\pi_t+\\gamma_t+k_t\\right) $$<\/p>\r\n<p>Where:<\/p>\r\n<ul>\r\n\t<li>\\(R\\) is the risk-free rate of interest.<\/li>\r\n\t<li>\\(\\theta_t\\) is the expected inflation.<\/li>\r\n\t<li>\\(\\pi_t\\) is the risk premium.<\/li>\r\n\t<li>\\(\\gamma_t\\) is the additional risk premium for credit risk (credit spread).<\/li>\r\n\t<li>\\(k_t\\) is the additional risk premium relative to risky debt for investment in the equities.<\/li>\r\n<\/ul>\r\n<div style=\"margin: 18px 0;\"><a style=\"display: block; text-align: center; padding: 14px 18px; border: 2px solid #2F5BFF; border-radius: 18px; color: #ffffff ; font-weight: 600; font-size: 16px; text-decoration: none; background-color: #1a73e8 ;\" href=\"https:\/\/analystprep.com\/free-trial\/\" target=\"_blank\" rel=\"noopener noreferrer\">Practice equity risk premium and consumption hedging concepts with our CFA Free Trial.<\/a><\/div>\r\n\r\n<p>The <strong>equity risk premium<\/strong> is the reward to investors over and above the compensation for risk required for holding a risk-free government bond. It is equal to \\((\\gamma_t+k_t)\\).<\/p>\r\n<p>The <strong>consumption hedging property<\/strong> highlights that the payoffs of securities during bad economic times matter more rather than their returns. In other words, assets that provide higher payoffs during economic downturns are highly valued because of the consumption hedging property. Thanks to this, such assets attract lower risk premiums.<\/p>\r\n<p>Equity provides a poor hedge against bad consumption outcomes. This is because when there is a recession, the value of equity declines. On the other hand, government bonds pay off substantially during bad economic times. A risk-averse investor would, therefore, demand a higher premium on an equity holding than a government bond holding. It is equity&#8217;s poor consumption hedging ability that informs such a preference.<\/p>\r\n<blockquote>\r\n<h2>Question<\/h2>\r\n<p>Which of the following statements about equity is the <em>least accurate<\/em>?<\/p>\r\n<ol type=\"A\">\r\n\t<li>Equity provides a poor hedge against bad consumption outcomes.<\/li>\r\n\t<li>Assets that provide a higher payoff during economic downturns have lower risk premiums.<\/li>\r\n\t<li>The consumption hedging property highlights that the payoff of a security during good economic times is what matters more than its return.<\/li>\r\n<\/ol>\r\n<h4>Solution<\/h4>\r\n<p><strong>The correct answer is C.<\/strong><\/p>\r\n<p>The consumption hedging property highlights that the payoff of a security during <strong>bad<\/strong> economic times is what matters more than its return.<\/p>\r\n<p><strong>A is incorrect.<\/strong>\u00a0Equity provides a poor hedge against bad consumption outcomes. This is because when there is a recession, the value of equity declines.<\/p>\r\n<p><strong>B is incorrect.<\/strong>\u00a0Assets that provide a higher payoff during economic downturns are highly valued because of the consumption hedging property. As such, the risk premiums on the asset are lower.<\/p>\r\n<\/blockquote>\r\n<p>Reading 43: Economics and Investment Markets<\/p>\r\n<p><em>LOS 43 (i) Explain the relationship between the consumption-hedging properties of equity and the equity risk premium.<\/em><\/p>\r\n\r\n<div style=\"text-align: center; margin: 30px 0;\"><a style=\"display: inline-flex; align-items: center; justify-content: center; padding: 12px 26px; border-radius: 9999px; background: #1e5bd8; color: #ffffff; font-weight: bold; text-decoration: none;\" href=\"https:\/\/analystprep.com\/free-trial\/\" target=\"_blank\" rel=\"noopener noreferrer\"> Start Free Trial \u2192 <\/a> <p style=\"margin-top: 12px; font-size: 16px; line-height: 1.5;\">Review the relationship between the consumption hedging properties of equity and the equity risk premium with CFA Level 2 study notes, practice questions, mock exams, and video lessons designed to strengthen your exam preparation.<\/p>\r\n <\/div>","protected":false},"excerpt":{"rendered":"<p>Equity refers to a security with an indefinite size and timing of dividends. Moreover, these dividends may stop in the event of bankruptcy. This makes equities riskier than debt. Equities, therefore, require an additional risk premium. More precisely, investors who&#8230;<\/p>\n","protected":false},"author":4,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[102,473],"tags":[216,564],"class_list":["post-19112","post","type-post","status-publish","format-standard","hentry","category-cfa-level-2","category-portfolio-management","tag-cfa-level-2","tag-portfolio-management","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v27.6 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Equity &amp; Equity Risk Premium | CFA Level II<\/title>\n<meta name=\"description\" content=\"Learn the equity risk premium, its role in compensating investors above risk-free rates, and how consumption-hedging properties affect asset pricing.\" \/>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/explain-the-relationship-between-the-consumption-hedging-properties-of-equity-and-the-equity-risk-premium\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Equity &amp; Equity Risk Premium | CFA Level II\" \/>\n<meta property=\"og:description\" content=\"Learn the equity risk premium, its role in compensating investors above risk-free rates, and how consumption-hedging properties affect asset pricing.\" \/>\n<meta property=\"og:url\" content=\"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/explain-the-relationship-between-the-consumption-hedging-properties-of-equity-and-the-equity-risk-premium\/\" \/>\n<meta property=\"og:site_name\" content=\"CFA, FRM, and Actuarial Exams Study Notes\" \/>\n<meta property=\"article:published_time\" content=\"2021-08-04T14:57:39+00:00\" \/>\n<meta property=\"article:modified_time\" content=\"2026-06-29T19:00:23+00:00\" \/>\n<meta name=\"author\" content=\"AnalystPrep Team\" \/>\n<meta name=\"twitter:card\" content=\"summary_large_image\" \/>\n<meta name=\"twitter:label1\" content=\"Written by\" \/>\n\t<meta name=\"twitter:data1\" content=\"AnalystPrep Team\" \/>\n\t<meta name=\"twitter:label2\" content=\"Est. reading time\" \/>\n\t<meta name=\"twitter:data2\" content=\"2 minutes\" \/>\n<script type=\"application\/ld+json\" class=\"yoast-schema-graph\">{\"@context\":\"https:\\\/\\\/schema.org\",\"@graph\":[{\"@type\":\"Article\",\"@id\":\"https:\\\/\\\/analystprep.com\\\/study-notes\\\/cfa-level-2\\\/explain-the-relationship-between-the-consumption-hedging-properties-of-equity-and-the-equity-risk-premium\\\/#article\",\"isPartOf\":{\"@id\":\"https:\\\/\\\/analystprep.com\\\/study-notes\\\/cfa-level-2\\\/explain-the-relationship-between-the-consumption-hedging-properties-of-equity-and-the-equity-risk-premium\\\/\"},\"author\":{\"name\":\"AnalystPrep Team\",\"@id\":\"https:\\\/\\\/analystprep.com\\\/study-notes\\\/#\\\/schema\\\/person\\\/ed0c939f3f12a02c5a193708b713d89e\"},\"headline\":\"Equity and Equity Risk Premium\",\"datePublished\":\"2021-08-04T14:57:39+00:00\",\"dateModified\":\"2026-06-29T19:00:23+00:00\",\"mainEntityOfPage\":{\"@id\":\"https:\\\/\\\/analystprep.com\\\/study-notes\\\/cfa-level-2\\\/explain-the-relationship-between-the-consumption-hedging-properties-of-equity-and-the-equity-risk-premium\\\/\"},\"wordCount\":468,\"keywords\":[\"CFA-level-2\",\"Portfolio management\"],\"articleSection\":[\"CFA Level II Study Notes\",\"Portfolio Management\"],\"inLanguage\":\"en-US\"},{\"@type\":\"WebPage\",\"@id\":\"https:\\\/\\\/analystprep.com\\\/study-notes\\\/cfa-level-2\\\/explain-the-relationship-between-the-consumption-hedging-properties-of-equity-and-the-equity-risk-premium\\\/\",\"url\":\"https:\\\/\\\/analystprep.com\\\/study-notes\\\/cfa-level-2\\\/explain-the-relationship-between-the-consumption-hedging-properties-of-equity-and-the-equity-risk-premium\\\/\",\"name\":\"Equity & Equity Risk Premium | CFA Level II\",\"isPartOf\":{\"@id\":\"https:\\\/\\\/analystprep.com\\\/study-notes\\\/#website\"},\"datePublished\":\"2021-08-04T14:57:39+00:00\",\"dateModified\":\"2026-06-29T19:00:23+00:00\",\"author\":{\"@id\":\"https:\\\/\\\/analystprep.com\\\/study-notes\\\/#\\\/schema\\\/person\\\/ed0c939f3f12a02c5a193708b713d89e\"},\"description\":\"Learn the equity risk premium, its role in compensating investors above risk-free rates, and how consumption-hedging properties affect asset pricing.\",\"breadcrumb\":{\"@id\":\"https:\\\/\\\/analystprep.com\\\/study-notes\\\/cfa-level-2\\\/explain-the-relationship-between-the-consumption-hedging-properties-of-equity-and-the-equity-risk-premium\\\/#breadcrumb\"},\"inLanguage\":\"en-US\",\"potentialAction\":[{\"@type\":\"ReadAction\",\"target\":[\"https:\\\/\\\/analystprep.com\\\/study-notes\\\/cfa-level-2\\\/explain-the-relationship-between-the-consumption-hedging-properties-of-equity-and-the-equity-risk-premium\\\/\"]}]},{\"@type\":\"BreadcrumbList\",\"@id\":\"https:\\\/\\\/analystprep.com\\\/study-notes\\\/cfa-level-2\\\/explain-the-relationship-between-the-consumption-hedging-properties-of-equity-and-the-equity-risk-premium\\\/#breadcrumb\",\"itemListElement\":[{\"@type\":\"ListItem\",\"position\":1,\"name\":\"Home\",\"item\":\"https:\\\/\\\/analystprep.com\\\/study-notes\\\/\"},{\"@type\":\"ListItem\",\"position\":2,\"name\":\"Equity and Equity Risk Premium\"}]},{\"@type\":\"WebSite\",\"@id\":\"https:\\\/\\\/analystprep.com\\\/study-notes\\\/#website\",\"url\":\"https:\\\/\\\/analystprep.com\\\/study-notes\\\/\",\"name\":\"CFA, FRM, and Actuarial Exams Study Notes\",\"description\":\"Question Bank and Study Notes for the CFA, FRM, and Actuarial exams\",\"potentialAction\":[{\"@type\":\"SearchAction\",\"target\":{\"@type\":\"EntryPoint\",\"urlTemplate\":\"https:\\\/\\\/analystprep.com\\\/study-notes\\\/?s={search_term_string}\"},\"query-input\":{\"@type\":\"PropertyValueSpecification\",\"valueRequired\":true,\"valueName\":\"search_term_string\"}}],\"inLanguage\":\"en-US\"},{\"@type\":\"Person\",\"@id\":\"https:\\\/\\\/analystprep.com\\\/study-notes\\\/#\\\/schema\\\/person\\\/ed0c939f3f12a02c5a193708b713d89e\",\"name\":\"AnalystPrep Team\",\"image\":{\"@type\":\"ImageObject\",\"inLanguage\":\"en-US\",\"@id\":\"https:\\\/\\\/secure.gravatar.com\\\/avatar\\\/0828fe7fdfdcf636b2061b4c563e20cc9b7453f7cd1641b4c43edbfba896727a?s=96&d=mm&r=g\",\"url\":\"https:\\\/\\\/secure.gravatar.com\\\/avatar\\\/0828fe7fdfdcf636b2061b4c563e20cc9b7453f7cd1641b4c43edbfba896727a?s=96&d=mm&r=g\",\"contentUrl\":\"https:\\\/\\\/secure.gravatar.com\\\/avatar\\\/0828fe7fdfdcf636b2061b4c563e20cc9b7453f7cd1641b4c43edbfba896727a?s=96&d=mm&r=g\",\"caption\":\"AnalystPrep Team\"},\"url\":\"https:\\\/\\\/analystprep.com\\\/study-notes\\\/author\\\/analystprep-team\\\/\"}]}<\/script>\n<meta property=\"og:video\" content=\"https:\/\/www.youtube.com\/embed\/NFyA0qXHhww\" \/>\n<meta property=\"og:video:type\" content=\"text\/html\" \/>\n<meta property=\"og:video:duration\" content=\"2852\" \/>\n<meta property=\"og:video:width\" content=\"480\" \/>\n<meta property=\"og:video:height\" content=\"270\" \/>\n<meta property=\"ya:ovs:adult\" content=\"false\" \/>\n<meta property=\"ya:ovs:upload_date\" content=\"2021-08-04T14:57:39+00:00\" \/>\n<meta property=\"ya:ovs:allow_embed\" content=\"true\" \/>\n<!-- \/ Yoast SEO plugin. -->","yoast_head_json":{"title":"Equity & Equity Risk Premium | CFA Level II","description":"Learn the equity risk premium, its role in compensating investors above risk-free rates, and how consumption-hedging properties affect asset pricing.","robots":{"index":"index","follow":"follow","max-snippet":"max-snippet:-1","max-image-preview":"max-image-preview:large","max-video-preview":"max-video-preview:-1"},"canonical":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/explain-the-relationship-between-the-consumption-hedging-properties-of-equity-and-the-equity-risk-premium\/","og_locale":"en_US","og_type":"article","og_title":"Equity & Equity Risk Premium | CFA Level II","og_description":"Learn the equity risk premium, its role in compensating investors above risk-free rates, and how consumption-hedging properties affect asset pricing.","og_url":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/explain-the-relationship-between-the-consumption-hedging-properties-of-equity-and-the-equity-risk-premium\/","og_site_name":"CFA, FRM, and Actuarial Exams Study Notes","article_published_time":"2021-08-04T14:57:39+00:00","article_modified_time":"2026-06-29T19:00:23+00:00","author":"AnalystPrep Team","twitter_card":"summary_large_image","twitter_misc":{"Written by":"AnalystPrep Team","Est. reading time":"2 minutes"},"schema":{"@context":"https:\/\/schema.org","@graph":[{"@type":"Article","@id":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/explain-the-relationship-between-the-consumption-hedging-properties-of-equity-and-the-equity-risk-premium\/#article","isPartOf":{"@id":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/explain-the-relationship-between-the-consumption-hedging-properties-of-equity-and-the-equity-risk-premium\/"},"author":{"name":"AnalystPrep Team","@id":"https:\/\/analystprep.com\/study-notes\/#\/schema\/person\/ed0c939f3f12a02c5a193708b713d89e"},"headline":"Equity and Equity Risk Premium","datePublished":"2021-08-04T14:57:39+00:00","dateModified":"2026-06-29T19:00:23+00:00","mainEntityOfPage":{"@id":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/explain-the-relationship-between-the-consumption-hedging-properties-of-equity-and-the-equity-risk-premium\/"},"wordCount":468,"keywords":["CFA-level-2","Portfolio management"],"articleSection":["CFA Level II Study Notes","Portfolio Management"],"inLanguage":"en-US"},{"@type":"WebPage","@id":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/explain-the-relationship-between-the-consumption-hedging-properties-of-equity-and-the-equity-risk-premium\/","url":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/explain-the-relationship-between-the-consumption-hedging-properties-of-equity-and-the-equity-risk-premium\/","name":"Equity & Equity Risk Premium | CFA Level II","isPartOf":{"@id":"https:\/\/analystprep.com\/study-notes\/#website"},"datePublished":"2021-08-04T14:57:39+00:00","dateModified":"2026-06-29T19:00:23+00:00","author":{"@id":"https:\/\/analystprep.com\/study-notes\/#\/schema\/person\/ed0c939f3f12a02c5a193708b713d89e"},"description":"Learn the equity risk premium, its role in compensating investors above risk-free rates, and how consumption-hedging properties affect asset pricing.","breadcrumb":{"@id":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/explain-the-relationship-between-the-consumption-hedging-properties-of-equity-and-the-equity-risk-premium\/#breadcrumb"},"inLanguage":"en-US","potentialAction":[{"@type":"ReadAction","target":["https:\/\/analystprep.com\/study-notes\/cfa-level-2\/explain-the-relationship-between-the-consumption-hedging-properties-of-equity-and-the-equity-risk-premium\/"]}]},{"@type":"BreadcrumbList","@id":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/explain-the-relationship-between-the-consumption-hedging-properties-of-equity-and-the-equity-risk-premium\/#breadcrumb","itemListElement":[{"@type":"ListItem","position":1,"name":"Home","item":"https:\/\/analystprep.com\/study-notes\/"},{"@type":"ListItem","position":2,"name":"Equity and Equity Risk Premium"}]},{"@type":"WebSite","@id":"https:\/\/analystprep.com\/study-notes\/#website","url":"https:\/\/analystprep.com\/study-notes\/","name":"CFA, FRM, and Actuarial Exams Study Notes","description":"Question Bank and Study Notes for the CFA, FRM, and Actuarial exams","potentialAction":[{"@type":"SearchAction","target":{"@type":"EntryPoint","urlTemplate":"https:\/\/analystprep.com\/study-notes\/?s={search_term_string}"},"query-input":{"@type":"PropertyValueSpecification","valueRequired":true,"valueName":"search_term_string"}}],"inLanguage":"en-US"},{"@type":"Person","@id":"https:\/\/analystprep.com\/study-notes\/#\/schema\/person\/ed0c939f3f12a02c5a193708b713d89e","name":"AnalystPrep Team","image":{"@type":"ImageObject","inLanguage":"en-US","@id":"https:\/\/secure.gravatar.com\/avatar\/0828fe7fdfdcf636b2061b4c563e20cc9b7453f7cd1641b4c43edbfba896727a?s=96&d=mm&r=g","url":"https:\/\/secure.gravatar.com\/avatar\/0828fe7fdfdcf636b2061b4c563e20cc9b7453f7cd1641b4c43edbfba896727a?s=96&d=mm&r=g","contentUrl":"https:\/\/secure.gravatar.com\/avatar\/0828fe7fdfdcf636b2061b4c563e20cc9b7453f7cd1641b4c43edbfba896727a?s=96&d=mm&r=g","caption":"AnalystPrep Team"},"url":"https:\/\/analystprep.com\/study-notes\/author\/analystprep-team\/"}]},"og_video":"https:\/\/www.youtube.com\/embed\/NFyA0qXHhww","og_video_type":"text\/html","og_video_duration":"2852","og_video_width":"480","og_video_height":"270","ya_ovs_adult":"false","ya_ovs_upload_date":"2021-08-04T14:57:39+00:00","ya_ovs_allow_embed":"true"},"_links":{"self":[{"href":"https:\/\/analystprep.com\/study-notes\/wp-json\/wp\/v2\/posts\/19112","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/analystprep.com\/study-notes\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/analystprep.com\/study-notes\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/analystprep.com\/study-notes\/wp-json\/wp\/v2\/users\/4"}],"replies":[{"embeddable":true,"href":"https:\/\/analystprep.com\/study-notes\/wp-json\/wp\/v2\/comments?post=19112"}],"version-history":[{"count":21,"href":"https:\/\/analystprep.com\/study-notes\/wp-json\/wp\/v2\/posts\/19112\/revisions"}],"predecessor-version":[{"id":44610,"href":"https:\/\/analystprep.com\/study-notes\/wp-json\/wp\/v2\/posts\/19112\/revisions\/44610"}],"wp:attachment":[{"href":"https:\/\/analystprep.com\/study-notes\/wp-json\/wp\/v2\/media?parent=19112"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/analystprep.com\/study-notes\/wp-json\/wp\/v2\/categories?post=19112"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/analystprep.com\/study-notes\/wp-json\/wp\/v2\/tags?post=19112"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}