Episode Overview
Podcast: Enterprising Investor (CFA Institute)
Episode: Rob Arnott: Rethinking Risk, Fear, and the Future of Asset Pricing
Date: September 15, 2025
Host: Mike Wahlberg
Guest: Rob Arnott (Founder & Chairman, Research Affiliates)
This episode features an in-depth conversation with Rob Arnott on the themes from his recent co-authored paper, "Fear Not Risk Explains Asset Pricing." The dialogue challenges long-standing assumptions about the equity risk premium, the validity of classical asset pricing models, and introduces a provocative rethinking: Are markets actually rewarding investor fear rather than risk? The episode blends empirical research, market history, and behavioral finance, calling for a shift in both academic theory and practitioner mindset.
1. Rethinking the Equity Risk Premium
[02:27–12:00]
Key Points
- Historical Assumptions Challenged: Rob discusses research with Ed McQuarrie that revisits whether stocks always outperform bonds, especially over very long horizons.
- Empirical Re-analysis: By reconstructing equity and bond returns from 1802 onward, McQuarrie finds stocks have not always beaten bonds, especially throughout the 19th century.
- The Impact of Revaluation: The major outperformance of stocks in the 20th century was propelled significantly by a dramatic rise in valuations, particularly between 1950 and 2000. This period is not reflective of a general rule.
"That 50-year span saw an eightfold rise in valuation of stocks measured against dividends... the revaluation alone accounts for 400 basis points of the stock market’s return per annum for 50 years." – Rob Arnott [06:23]
- Risk Premium Reality: Once you remove the effect of revaluation, the risk premium is much smaller than widely assumed—about 2.5% rather than 4.5%.
- Tactical vs. Strategic Allocation: The apparent outperformance of stocks is sometimes more a byproduct of tactical opportunities than a constant, reliable risk premium.
Notable Quote
“The stock versus bond decision is lightly based on a presumptive risk premium and heavily based on a tactical evaluation of which is priced to produce a higher return.” — Rob Arnott [09:19]
2. CAPM and the Nature of Risk Aversion
[11:57–16:38]
Key Points
- CAPM’s Flawed Symmetry: Arnott explains that the classical Capital Asset Pricing Model (CAPM) assumes investors dislike volatility—up or down—equally, which contradicts behavioral finance findings.
- Behavioral Reality: Humans are far more averse to downside volatility than they are to upside; in fact, they seek upside “risk.”
“Are you more uneasy about downside volatility or upside volatility? I’m guessing that somewhere around 99.9% of us say: I don’t like downside volatility. I love upside volatility.” — Rob Arnott [12:12]
- Bridging Theory and Behavior: The current risk-focused models lack acknowledgment of human psychology (loss aversion, FOMO).
Notable Quote
“Neoclassical finance theory posits that you have this symmetric risk aversion, which we know is false.” — Rob Arnott [12:32]
3. Toward a New Framework: Fear, Skew, and Sentiment
[16:38–21:09]
Key Points
- Invitation to Academia: The paper is a call to action, proposing a framework that integrates both fear of loss and fear of missing upside.
“We’re not proposing a new paradigm. We’re proposing a framework for a new paradigm that we encourage others to develop.” — Rob Arnott [17:23]
- Potential Quantitative Tools: Suggestions include measuring downside risk (semivariance) and upside risk (skew), rather than relying solely on variance.
- Application of AI: AI could revolutionize the measurement of sentiment, harnessing real-time analysis of news, publications, and social media to quantify market fears and FOMO.
“AI… is phenomenal. People who don’t play around with it for several hours a week are missing an opportunity.” — Rob Arnott [21:09]
- Anecdote: Arnott describes asking the “Perplexity” AI system to critique their paper; the response was as insightful as top-tier peer reviews.
4. Implication for Asset Management and Portfolio Construction
[23:33–27:22]
Key Points
- From Theory to Practice: Incorporating measures of fear (both of downside and missing upside) could refine stock selection, asset allocation, and tactical decisions.
- Momentum in Fear: Acknowledging “momentum” in FOMO or panic could help inform when to ride trends or rebalance portfolios.
“There may be a momentum component that can help us stay in a frothy market until the turning point is closer.” — Rob Arnott [26:26]
Example Scenario
- If high FOMO is detected (valuations stretched due to crowding into a narrative), it may warrant underweighting equities—not just because they’re expensive, but based on quantifiable sentiment signals.
Notable Quote
“Mostly, the paper is a call to action for academia to please stop futzing around with a framework that you know is false.” — Rob Arnott [27:02]
5. Rob Arnott’s Career Reflections & Advice
[27:45–31:44]
Key Points
- Origins: Rob tailored his education toward investment, opting for applied mathematics, computer science, and economics to maximize his impact on finance.
- First Job Story: His initial role at the Boston Company allowed for one day per week of pure research—a pivotal career decision.
- Advice to Young Self: “When you learn something new that is contrary to conventional wisdom, just be aware you’re going to make a lot of people very angry.”
- Anecdote: The reception to his famous “Death of the Risk Premium” paper was initially hostile; only later did peers acknowledge its validity.
- Theme: Curiosity and the willingness to challenge orthodoxy have underpinned his most meaningful contributions.
Notable Quote
“If something is a conventionally held view, I will just automatically ask the question, has anyone tested that? And if not, I’ll go test it.” — Rob Arnott [31:35]
6. Memorable Moments & Quotes
-
On the call for new research:
“This is an invitation for those who are extraordinary at math… to go win a Nobel Prize by reshaping CAPM, to embrace the asymmetric fears, which are a fear of loss and a fear of missing upside.” — Rob Arnott [15:36]
-
On technological progress in finance:
“Somebody who knows how to use AI better than you do may take your job. So study, get used to it, play around with it…” — Rob Arnott [21:25]
7. Key Timestamps for Important Segments
- 03:30–09:30: Historical returns analysis and revisiting the equity risk premium
- 12:00–16:40: CAPM critique and behavioral finance integration
- 17:20–21:30: New paradigm framework and the potential use of AI
- 23:45–27:00: Asset management, tactical asset allocation, and portfolio construction
- 27:50–32:00: Career insights, advice for new entrants, and stories on challenging conventions
Tone/Style:
As in the episode, the tone is frank and exploratory—Arnott uses clear, candid language and humor (“You son of a bitch, you told the secrets!” [24:47]), and the conversation is both rigorous and inviting, a blend of experience-based wisdom and curiosity.
For Further Reading
- Paper discussed: Fear Not Risk Explains Asset Pricing (Arnott & McQuarrie, 2025)
- Relevant prior work: “Death of the Risk Premium” (Arnott, 2001)
Summary prepared for professionals and students seeking a thorough, detailed understanding of the episode’s arguments and insights, preserving the flavor and key voice of the speakers.