The Equity Premium: Why is it a Puzzle?
Posted: 29 Apr 2003
This article takes a critical look at the equity premium puzzle - the inability of standard intertemporal economic models to rationalize the statistics that have characterized U.S. financial markets over the past century. A summary of historical returns for the United States and other industrialized countries and an overview of the economic construct itself are provided. The intuition behind the discrepancy between model prediction and empirical data is explained. After detailing the research efforts to enhance the model's ability to replicate the empirical data, I argue that the proposed resolutions fail along crucial dimensions.
Keywords: Investment Theory: CAPM, APT, and other pricing theories; Portfolio Management: asset allocation
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