The Resource-Constrained Brain: A New Perspective on the Equity Premium Puzzle

Abstract

Findings from brain sciences show that the brain must first optimize on its own internal resources before seeking to optimize on the resources available in the external world. We show that this modest change is perspective, from resource-constrained humans to resource-constrained brains, provides a new perspective on how assets are priced in financial markets. We show that the brain-centric perspective potentially lowers the risk-aversion needed to reconcile consumption data with asset prices, and can contribute to countercyclical equity premia. We show that the brain-centric perspective can be easily integrated with several existing approaches on the equity premium puzzle; hence, opening the door to a dual-approach resolution of key macro-finance puzzles.

Keywords: Equity Premium, Countercyclical Equity Premia, Resource Allocation in the Brain, Macro-Finance

JEL Classification: G12, G10, G00, G40, G41