However, even if we think we understand the trends, the challenges become more pressing when we look at movements in, and relationships among, risk premiums as they happen. Our first challenge is to determine when a movement is not just noise that will quickly reverse, but rather a signal of something important that we need to understand as we formulate policy.
For example, does the backup in the equity risk premium over the past year arise from some deep-seated and long-lasting macroeconomic cause that we need to consider for our policy decisions, or is it a mere blip? To separate signal from noise, we try to look not only at the persistence of movements but also at their correlation across markets.