Equity Premium Puzzle or Faulty Economic Modelling?

13 Pages Posted: 4 Mar 2020

See all articles by Abootaleb Shirvani

Abootaleb Shirvani

Texas Tech University - Department of Mathematics and Statistics

Stoyan V. Stoyanov

Charles Schwab

Frank J. Fabozzi

EDHEC Business School

Svetlozar T. Rachev

Texas Tech University

Date Written: February 3, 2020

Abstract

In this paper, we revisit the equity premium puzzle reported in 1985 by Mehra and Prescott. We show that the large equity premium that they report can be explained by choosing a more appropriate distribution for the return data. We demonstrate that the high-risk aversion value observed by Mehra and Prescott may be attributable to the problem of fitting a proper distribution to the historical returns and partly caused by poorly fitting the tail of the return distribution. We describe a new distribution that better ts the return distribution and when used to describe historical returns can explain the large equity risk premium and thereby explains the puzzle.

Keywords: Rational Finance, Equity Premium Puzzle, Normal compound inverse Gaussian distribution

JEL Classification: G00, G14,

Suggested Citation

Shirvani, Abootaleb and Stoyanov, Stoyan Veselinov and Fabozzi, Frank J. and Rachev, Svetlozar T., Equity Premium Puzzle or Faulty Economic Modelling? (February 3, 2020). Available at SSRN: https://ssrn.com/abstract=3530635 or http://dx.doi.org/10.2139/ssrn.3530635

Abootaleb Shirvani (Contact Author)

Texas Tech University - Department of Mathematics and Statistics ( email )

Lubbock, TX 79409-1042
United States

Stoyan Veselinov Stoyanov

Charles Schwab ( email )

101 Montgomery Street (120K-15)
San Francisco, CA 94104
United States

Frank J. Fabozzi

EDHEC Business School ( email )

France
215 598-8924 (Phone)

Svetlozar T. Rachev

Texas Tech University ( email )

2500 Broadway
Lubbock, TX 79409
United States

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