Structural Risk Premia - They are all around you but may not last

There are number of risk premia styles, but styles tell how risk premia are exploited not why they exist. The reason for existence is key to whether a risk premium can be exploited over the long-run or is likely to disappear. The risk premia could be classified in three categories: fundamental, behavioral or structural. 

• Fundamental risk premia are associated with compensation for risk due to the inherent characteristics of the securities such as quality, size, carry, or volatility.
• Behavioral risk premia are associated with returns generated from the under or over-reaction to information caused by behavioral. For example, momentum is associated with behavioral biases that create trends.
• Structural risk premia are associated with return from inefficiencies created by market structure, rules, and regulation. Rules and structure impact liquidity, flows, and the ability of markets to eliminate arbitrage. For example, insurance and bank regulation impact liquidity through investment restrictions. 

The fundamental and behavior risk premia are most often identified and discussed by investors. The fundamental risk premia are driven by an economic and theoretical rational for risk compensation. The behavioral risk premia fit within or current thinking of market behavior. Both fundamental and behavior risk premia should be persistent through time. These premia may be time varying but should offer investors long-term positive returns.

Structural risk premia are different in that are related to man-made rules and regulations. A change in market structure can eliminate the premia. They are not immediately obvious and may not have a theoretical or economic rational outside of the structural frictions. While behavioral biases may affect these risk premia, investors can be very rational and still have these structural opportunities. However, these risk premia may be arbitraged away if there is enough capital to offset the structural inefficiencies. Hence, structural risk premia are not persistent, yet they may be everywhere if you look closely at market microstructure. 

A list of some structural risk premia:

• Commodities - Liquidity congestion premia associated with contract rolls.
• Rates - Money fund maturity restrictions.
• Credit - Restrictions on ratings against high yield. 
• Currencies - Trading in non-deliverable forwards.
• Equities - Index composition liquidity effects.

For some investors that focus on the micro details of markets, these are tradable opportunities. Perhaps not like finding dollar bills on the sidewalk, but these premia that can be profitable albeit fleeting with a change in the rules.