Using Long Term Implied Volatilities to Assess Past and Present U.S. Stock Prices
21 Pages Posted: 1 Jan 2020
Date Written: December 12, 2019
This paper empirically analyzes a model that relates earnings price ratios to long term risk free rates and implied volatilities. The two periods with sufficient available data are 1890-1933, and 2007-2019. I estimate that modern investors have relative risk aversion of 1.34 and a time preference discount of 2.77%,while their historical counterparts have a relative risk aversion of 1.50 and a 6.42% discount. The paper studies if prices were efficient in Black's (1986) sense, and finds that while an error correction model works well for the modern period, and for 1890 to 1927, coherence breaks down completely from 1928 to 1933.
Keywords: Efficient markets hypothesis, Implied volatilities, equity risk premium puzzle, risk free rate puzzle.
JEL Classification: D53, D81, G12, G13, E44
Suggested Citation: Suggested Citation