I am utterly clueless about this paragraph below from " Economics and Investment Markets "

“An asset’s risk premium is driven by the covariance of its returns with the inter-temporal rate of substitution for consumption and can exist even for a default-free bond because of the uncertainty of its price before maturity. Most risky assets have returns that tend to be high during good times, when the marginal value of consumption is low, and low during bad times,when the marginal value of consumption is high, and so bear a positive risk premium. Any asset that tended to have relatively high returns when the marginal utility of consumption was high would provide a type of hedge against bad times, bear a negative risk premium, and have a relatively high price and low required rate of return.”

Any help very much appreciated

Broadly speaking:

  1. Most assets can be thought of as giving up consumption today in the expectation that the asset will allow you to consume more in the future. How much you are willing to give up today is known as the inter-temporal rate of substitution.
  1. The assets which tend to do well during ‘good’ economic times (like equities) are also the assets which tend to do worse during ‘bad’ economic times and it is during these ‘bad’ economic times that you place a higher value on having consumption now rather than at some future point. You would want a higher risk premium on these assets to compensate you for this risk.

  2. Therefore an asset’s risk premium will increase with its covariance with the inter-temporal rate of substitution.