Can Rare Events Explain the Equity Premium Puzzle?

53 Pages Posted: 4 Apr 2012

See all articles by Anisha Ghosh

Anisha Ghosh

McGill University

Christian Julliard

London School of Economics & Political Science (LSE) - Department of Finance; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: March 2012

Abstract

Probably not. First, allowing the probabilities of the states of the economy to differ from their sample frequencies, the Consumption-CAPM is still rejected in both U.S. and international data. Second, the recorded world disasters are too small to rationalize the puzzle unless one assumes that disasters occur every 6-10 years. Third, if the data were generated by the rare events distribution needed to rationalize the equity premium puzzle, the puzzle itself would be unlikely to arise. Fourth, the rare events hypothesis, by reducing the cross-sectional dispersion of consumption risk, worsens the ability of the Consumption-CAPM to explain the cross-section of returns.

Keywords: Calibration, Cross-Section of Asset Returns, Equity Premium Puzzle, Generalized Empirical Likelihood, Peso Phenomenon, Rare Disasters, Rare Events, Semi-parametric Bayesian Inference

JEL Classification: C11, C14, E17, G12

Suggested Citation

Ghosh, Anisha and Julliard, Christian, Can Rare Events Explain the Equity Premium Puzzle? (March 2012). CEPR Discussion Paper No. DP8899, Available at SSRN: https://ssrn.com/abstract=2034117

Anisha Ghosh (Contact Author)

McGill University ( email )

1001 Sherbrooke St. W
Montreal, Quebec H3A 1G5
Canada

Christian Julliard

London School of Economics & Political Science (LSE) - Department of Finance ( email )

United Kingdom

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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