Sad that the tweet this was replying to got deleted, it was a good learning opportunity!https://twitter.com/macrocephalopod/status/1391865409561899008 …
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The clearest example of a risk premia in my mind is dividend futures, where obviously the expectation is that dividends will generally increase year on year, but the dividend futures curve is almost always backwardated, i.e. far dividends can be bought for less than nearby divs.
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The reason is risk premia -- obviously dividends are correlated with stocks, and taking the risk on long-term dividends requires a much bigger discount than a relatively safe bet on near-term dividends.
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Expectations + risk premia explain most prices, most of the time. It gets interesting when there are technical effects, e.g. a liquidity crisis, short squeeze, very constrained or forced actors etc. In these cases prices can trade far away from any sensible level, and in an
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extreme case there is basically no limit to how far they can trade away, because it would require a rational actor to trade on the crazy prices to make them non-crazy, and "technical effects" basically means that rational actors are too constrained to act.
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I contend that this (admittedly ludicrously general) model can explain 90% of all prices in any market. For the 10% it can't explain just wave your hands and say "tax arb".
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End of conversation
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