Question

Provide a definition of term premium. Write the expression for term premium used in the Time Varying Risk Hypothesis and the Market Segmentation Hypothesis.

Answer 1

Premium is the amount which paid periodically to insurer by insured to cover the risk. The risk is transferred from insured to insurer in an insurance contract. While taking the risk, the insurer charge an amount called premium. The payment frequency can be different for different premium. It can be paid in monthly, quarterly, semi annually, annually or in a single period also.
In Time Varying Risk Hypothesis, the risk premiums are predictable. There is an equity premium prevail here. The equity premium predicts through dividend - price ratio. When this ratio will be high the returns will also very high.
The market segmentation hypothesis explains that the long term and short term interest rates are not related to each other. Here the premium will differ for different interest rates. The yield of groups are different from each other.