Equity Premium Puzzle or Faulty Economic Modelling?

Abootaleb Shirvani, Stoyan V. Stoyanov, Frank J. Fabozzi and Svetlozar T. Rachev

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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.

Date: 2019-09, Revised 2020-01
New Economics Papers: this item is included in nep-fmk, nep-his and nep-upt
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Persistent link: https://EconPapers.repec.org/RePEc:arx:papers:1909.13019

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