The Equity Premium Puzzle: A Reconciliation
29 Pages Posted: 22 Jul 2008 Last revised: 17 Mar 2011
Date Written: July 21, 2008
Abstract
This paper estimates the risk aversion for households accounting for their lifetime consumption risk. Households view the overall lifetime uninsured consumption risk when they optimize resources, which based on micro data varies across households. Thus, representing households’ consumption by merging cross-sectional micro data into the single Euler equation (the common approach taken in the literature) may be too rough an approximation and lead to biased results regarding risk aversion. Our results indicate that rejected asset pricing models fit the data when we account for households' lifetime consumption risk. Our empirical success has also implications on long-run aggregate asset pricing models.
Keywords: The equity premium puzzle, asset pricing, macroeconomics
JEL Classification: G12
Suggested Citation: Suggested Citation
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