scholarly journals THE EQUITY PREMIUM PUZZLE AND EMOTIONAL ASSET PRICING

2007 ◽  
Vol 10 (06) ◽  
pp. 939-965 ◽  
Author(s):  
MARC GÜRTLER ◽  
NORA HARTMANN
Keyword(s):  
Asset Pricing ◽  
Stock Market ◽  
Equity Premium ◽  
Economic Modeling ◽  
Behavioral Decision Theory ◽  
Market Data ◽  
Disappointment Theory ◽  
Premium Puzzle ◽  
Risk Free Rate ◽  
Free Rate

Since the equity premium as well as the risk-free rate puzzle question the concepts central to financial and economic modeling, we apply behavioral decision theory to asset pricing in view of solving these puzzles. US stock market data for the period 1960–2003 and German stock market data for the period 1977–2003 show that emotional investors who act in accordance to Bell's [6] disappointment theory — a special case of prospect theory — and additionally administer mental accounts demand a high equity premium. Furthermore, these investors reason a low risk-free rate. However, Barberis et al. [5] already showed that limited rational investors demand a high equity premium. But as opposed to them, our approach additionally supports dividend smoothing.

scholarly journals Asset Pricing with Distorted Beliefs: Are Equity Returns Too Good to Be True?

2000 ◽  
Vol 90 (4) ◽  
pp. 787-805 ◽  
Author(s):  
Stephen G Cecchetti ◽  
Pok-Sang Lam ◽  
Nelson C Mark
Keyword(s):  
Asset Pricing ◽  
Equity Premium ◽  
Equity Returns ◽  
Relative Risk Aversion ◽  
Pricing Model ◽  
Asset Pricing Model ◽  
Subjective Beliefs ◽  
Second Moments ◽  
Risk Free Rate ◽  
Free Rate

We study a Lucas asset-pricing model that is standard in all respects, except that the representative agent's subjective beliefs about endowment growth are distorted. Using constant relative risk-aversion (CRRA) utility, with a CRRA coefficient below 10; fluctuating beliefs that exhibit, on average, excessive pessimism over expansions; and excessive optimism over contractions (both ending more quickly than the data suggest), our model is able to match the first and second moments of the equity premium and risk-free rate, as well as the persistence and predictability of excess returns found in the data. (JEL E44, G12)

THE SPIRIT OF CAPITALISM, ASSET RETURNS, AND THE BUSINESS CYCLE

2007 ◽  
Vol 11 (2) ◽  
pp. 214-230 ◽  
Author(s):  
MARTIN BOILEAU ◽  
REBECCA BRAEU
Keyword(s):  
Business Cycle ◽  
Equity Premium ◽  
Asset Return ◽  
Spirit Of Capitalism ◽  
Business Cycle Model ◽  
The Business Cycle ◽  
Premium Puzzle ◽  
Risk Free Rate ◽  
Free Rate ◽  
Real Business Cycle Model

We evaluate whether the spirit of capitalism improves the ability of the real business cycle model to explain the main features of both asset return and the business cycle. In our model, the spirit of capitalism is embodied in the assumption that individuals have preferences for financial wealth. Our simulation results suggest that this assumption may improve the model's ability to explain the risk-free rate puzzle but not the equity premium puzzle. This assumption also markedly deteriorates the model's ability to account for the main features of the business cycle.

scholarly journals When Uncertainty and Volatility Are Disconnected: Implications for Asset Pricing and Portfolio Performance

2021 ◽  
Vol 2021 (063) ◽  
pp. 1-49
Author(s):  
Yacine Aït-Sahalia ◽  
◽  
Felix Matthys ◽  
Emilio Osambela ◽  
Ronnie Sircar ◽  
...  
Keyword(s):  
Asset Pricing ◽  
Empirical Analysis ◽  
Asset Allocation ◽  
Equity Premium ◽  
Equity Market ◽  
Portfolio Performance ◽  
Market Return ◽  
Risk Free Rate ◽  
Free Rate ◽  
High Uncertainty

We analyze an environment where the uncertainty in the equity market return and its volatility are both stochastic and may be potentially disconnected. We solve a representative investor's optimal asset allocation and derive the resulting conditional equity premium and risk-free rate in equilibrium. Our empirical analysis shows that the equity premium appears to be earned for facing uncertainty, especially high uncertainty that is disconnected from lower volatility, rather than for facing volatility as traditionally assumed. Incorporating the possibility of a disconnect between volatility and uncertainty significantly improves portfolio performance, over and above the performance obtained by conditioning on volatility only.

A Monetary Explanation of the Equity Premium, Term Premium, and Risk-Free Rate Puzzles

1996 ◽  
Vol 104 (6) ◽  
pp. 1135-1171 ◽  
Author(s):  
Ravi Bansal ◽  
Wilbur John Coleman
Keyword(s):  
Equity Premium ◽  
Term Premium ◽  
Risk Free Rate ◽  
Free Rate
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