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Some solutions to the equity premium and volatility puzzles

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  • Li, Jinlu

Abstract

In this paper, I adopt an economic equilibrium model utilizing the framework introduced by Mehra and Prescott (1985) when they presented the equity premium puzzle. This model, in the long run and with respect to stationary probabilities, produces results that match the sample values derived from the U.S. economy between 1889 and 1978 as illustrated by the studies performed by Grossman and Shiller (1981), which includes the expected average, standard deviation, and first-order serial correlation of the growth rate of per capita real consumption and the expected returns and standard deviation of equity, risk-free security, and risk premium for equity. Therefore, this model solves the equity premium and volatility puzzles. I also explore the reasons why the equity premium puzzle was caused.

Suggested Citation

  • Li, Jinlu, 2010. "Some solutions to the equity premium and volatility puzzles," MPRA Paper 26833, University Library of Munich, Germany, revised 01 Aug 2010.
    • Handle: RePEc:pra:mprapa:26833
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    References listed on IDEAS

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    1. Otrok, Christopher & Ravikumar, B. & Whiteman, Charles H., 2002. "Habit formation: a resolution of the equity premium puzzle?," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1261-1288, September.
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    5. Bansal, Ravi & Coleman, Wilbur John, II, 1996. "A Monetary Explanation of the Equity Premium, Term Premium, and Risk-Free Rate Puzzles," Journal of Political Economy, University of Chicago Press, vol. 104(6), pages 1135-1171, December.
    6. Mankiw, N. Gregory, 1986. "The equity premium and the concentration of aggregate shocks," Journal of Financial Economics, Elsevier, vol. 17(1), pages 211-219, September.
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    More about this item

    Keywords

    The constant relative risk aversion class utility function; risk premium; time discount factor; parameters defining preferences; parameters defining technologies; the equity premium and volatility puzzles.;
    All these keywords.

    JEL classification:

    • C02 - Mathematical and Quantitative Methods - - General - - - Mathematical Economics
    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
    • E01 - Macroeconomics and Monetary Economics - - General - - - Measurement and Data on National Income and Product Accounts and Wealth; Environmental Accounts

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