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Composite-asset-risk approach to solving the equity premium puzzle

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  • Kim, Yun-Yeong

Abstract

We demonstrate that the equity premium puzzle can be explained by a combination of modern portfolio theory (MPT) and a consumption capital asset pricing model (CAPM). We assume that an investor maximizes her/his utility as determined by the expected return and risk for a composite asset portfolio including purchasing an equity and selling a riskless asset jointly. If the variance of the composite asset is greater than that expected by the CAPM, then the equity premium puzzle can be resolved according to the MPT. The intrinsic bubbles may explain the observed excessive expectation and variance of equity return premium.

Suggested Citation

  • Kim, Yun-Yeong, 2021. "Composite-asset-risk approach to solving the equity premium puzzle," International Review of Economics & Finance, Elsevier, vol. 71(C), pages 200-216.
    • Handle: RePEc:eee:reveco:v:71:y:2021:i:c:p:200-216
    DOI: 10.1016/j.iref.2020.08.017
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    More about this item

    Keywords

    Equity premium puzzle; Consumption CAPM; Composite asset; Nonstationary risk; Intrinsic bubbles;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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