 Mortgage payments and equity premium puzzleTien Foo Sing and Yiheng Zou The Quarterly Review of Economics and Finance, 2022, vol. 86, issue C, 376-388 Abstract: The equity premium puzzle argues that equity risk alone is insufficient to justify observed equity premiums with a reasonable value of risk aversion. Mortgages account for a substantial part of household debt. It is thus necessary to consider the mortgage payment obligations when addressing the puzzle. This paper examines how the mortgage payment obligations affect the stochastic discount factor in the pricing kernel and influence the equity premium. The proposed asset pricing model incorporating the mortgage payment factor explains the observed equity premium with an acceptable risk aversion value of 1.2. Mortgage payments affect the utility function in two dimensions. First, the payments hurt individuals by decreasing their overall utility level. Second, the counter-cyclical effect of the payments benefits individuals by decreasing the volatility of the utility stream. This paper contributes to the literature by highlighting the importance of mortgages in predicting the equity premium. Keywords: Equity premium puzzle; Mortgage payments; Household debt; Stochastic discount factor; Risk aversion (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:quaeco:v:86:y:2022:i:c:p:376-388 DOI: 10.1016/j.qref.2022.08.004 Access Statistics for this article The Quarterly Review of Economics and Finance is currently edited by R. J. Arnould and J. E. Finnerty More articles in The Quarterly Review of Economics and Finance from Elsevier |
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