Equity premium puzzle or faulty economic modelling?

Abootaleb Shirvani (), Stoyan V. Stoyanov (), Frank J. Fabozzi () and Svetlozar T. Rachev ()
Additional contact information
Abootaleb Shirvani: Texas Tech University
Stoyan V. Stoyanov: Charles Schwab Corporation
Frank J. Fabozzi: EDHEC Business School
Svetlozar T. Rachev: Texas Tech University

Review of Quantitative Finance and Accounting, 2021, vol. 56, issue 4, No 4, 1329-1342

Abstract: Abstract In this paper we revisit the equity premium puzzle reported in 1985 by Mehra and Prescott. We show that the large equity premium that they report can be explained by choosing a more appropriate distribution for the return data. We demonstrate that the high-risk aversion value observed by Mehra and Prescott may be attributable to the problem of fitting a proper distribution to the historical returns and partly caused by poorly fitting the tail of the return distribution. We describe a new distribution that better fits the return distribution and when used to describe historical returns can explain the large equity risk premium and thereby explains the puzzle.

Keywords: Rational finance; Equity premium puzzle; Normal compound inverse Gaussian distribution (search for similar items in EconPapers)
JEL-codes: C10 C13 C18 (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:kap:rqfnac:v:56:y:2021:i:4:d:10.1007_s11156-020-00928-3

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DOI: 10.1007/s11156-020-00928-3

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