Equity Premium and Risk-Free Rate: Insights from a Dynamic Quantile Preference Model 

Abstract

This paper examines the asset pricing implications of dynamic quantile preferences. Despite smooth consumption growth, the model matches the observed equity premium and risk-free rate with plausible risk aversion and elasticity of intertemporal substitution (EIS). This empirical success stems from two key features of the model. First, quantile preferences display first-order risk aversion. Second, they imply a constant elasticity of substitution between current consumption and consumption in any future state. Consequently, risk aversion and EIS play distinct roles: the former mainly determines the equity premium, while the latter primarily governs the risk-free rate, overcoming a key limitation of the Epstein–Zin utility.

Keywords: Quantile Preferences, Recursive Model, Asset Pricing, Equity Premium Puzzle