Is There Evidence of Pessimism and Doubt in Subjective Distributions? Implications for the Equity Premium Puzzle
27 Pages Posted: 3 Jun 2009 Last revised: 11 Jun 2013
Date Written: April 27, 2005
Abel (2002) shows that pessimism and doubt in the subjective distribution of the growth rate of consumption reduce the equity premium puzzle. We quantify the amount of pessimism and doubt in survey data on US consumption and income. Individual forecasters are in fact pessimistic, but show marked overconfidence rather than doubt. However, the implications for Abel's model depends on how the empirically heterogeneous beliefs are mapped into beliefs of a representative agent. We use an Arrow-Debreu economy to show that disagreement increases the equity premium. When incorporating this in our estimation, we find little empirical evidence of either overconfidence or doubt.
Keywords: equity premium, riskfree rate, aggregation of beliefs, Survey of Professional Forecasters, Livingston Survey
JEL Classification: C42, G12, E44
Suggested Citation: Suggested Citation