Estimation Uncertainty and the Equity Premium

International Review of Finance, Forthcoming

38 Pages Posted: 17 Aug 2009

See all articles by Hong Yan

Hong Yan

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF)

Multiple version iconThere are 2 versions of this paper

Date Written: June 12, 2009

Abstract

This paper studies a dynamic equilibrium model of asset prices in a partially observable exchange economy. It shows that the precautionary savings motive in response to estimation uncertainty can dominate the risk aversion effect, resulting in the reduction of the equity premium over short horizons. This exacerbates the equity premium puzzle. Over longer holding horizons, however, estimation uncertainty does induce higher risk premiums on equity over risk-free coupon bonds of matching maturities, as long-term bond yields are lowered due to the precautionary savings effect.

Keywords: equity premium, estimation risk, precautionary savings, learning, long-horizon expected return

JEL Classification: E1, E43, E44, G1, G12

Suggested Citation

Yan, Hong, Estimation Uncertainty and the Equity Premium (June 12, 2009). International Review of Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1455908

Hong Yan (Contact Author)

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF) ( email )

Shanghai Jiao Tong University
211 West Huaihai Road
Shanghai, 200030
China

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