Red Tape Asset Pricing
Discussion Papers on Business and Economics, University of Southern Denmark, 8/2018
43 Pages Posted: 26 Dec 2018 Last revised: 29 Jan 2019
Date Written: January 28, 2019
The equity premium–risk-free rate puzzle in standard consumption-based asset pricing models disappears once we remove the government-imposed component from the consumption expenditure series. I calibrate this component based on the growth rates of two proxies for government intervention, which I also show to forecast the short- and long-term equity premiums between 1974 (or 1981) and 2017. In summary, investors require large premiums to hold stocks because stocks give poor returns when government intervention increases, thereby systematically reducing individuals’ utility levels.
Keywords: Equity Premium Puzzle, Intervention, Regulation, Risk
JEL Classification: G1, E1, H1
Suggested Citation: Suggested Citation