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A model of mean reversion in stock prices and the Equity Premium Puzzle

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  • Maruyama, Yuuki

Abstract

In this model, the stock price is determined by two variables: the fundamental value and the current risk preference of people. Suppose that the fundamental value follows Geometric Brownian motion and the function of the risk preference of people follows Ornstein-Uhlenbeck process. There are only two types of asset: money (safe asset) and stocks (risk asset). In this case, the profit rate of equity investment is mean reverting, and long-term investment is more advantageous than short-term investment. The market is arbitrage-free. Also, based on this model, I suggest a solution to the Equity Premium Puzzle.

Suggested Citation

  • Maruyama, Yuuki, 2019. "A model of mean reversion in stock prices and the Equity Premium Puzzle," OSF Preprints 6gwjq, Center for Open Science.
    • Handle: RePEc:osf:osfxxx:6gwjq
    DOI: 10.31219/osf.io/6gwjq
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