Mayfield (2004) estimated the market risk premium in the ICAPM framework that accounts
for changes in investment opportunities. We claim that these estimates were inconsistent
due to an endogeneity problem associated with the assumption that investors
have perfect knowledge about the volatility states. We estimate the market risk premium
controlling for the endogeneity. Our empirical results show that imposing this perfect
knowledge assumption understates the total market risk premium and overstates the relative
importance of the risk premium for shifts in investment opportunities.
