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One trade at a time -- unraveling the Equity Premium Puzzle

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  • Andrei N. Soklakov

Abstract

Financial markets provide a natural quantitative lab for understanding some of the most advanced human behaviours. Among them is the use of mathematical tools known as financial instruments. Besides money, the two most fundamental financial instruments are bonds and equities. More than 30 years ago Mehra and Prescott found the numerical performance of equities relative to government bonds could not be explained by consumption-based (mainstream) economic theories. This empirical observation, known as the Equity Premium Puzzle, has been defying mainstream economics ever since. The recent financial crisis revealed an even deeper need for understanding financial products. We show how understanding the rational nature of product design resolves the Equity Premium Puzzle. In doing so we obtain an experimentally tested theory of product design.

Suggested Citation

  • Andrei N. Soklakov, 2015. "One trade at a time -- unraveling the Equity Premium Puzzle," Papers 1507.07214, arXiv.org, revised Aug 2020.
    • Handle: RePEc:arx:papers:1507.07214
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    Cited by:

    1. Andrei N. Soklakov, 2022. "Information Geometry of Risks and Returns," Papers 2206.08753, arXiv.org, revised Jun 2023.
    2. Andrei N. Soklakov, 2015. "Why Quantitative Structuring?," Papers 1507.07219, arXiv.org, revised Sep 2020.
    3. Andrei N. Soklakov, 2015. "Model Risk Analysis via Investment Structuring," Papers 1507.07216, arXiv.org, revised Jul 2015.

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