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The Equity Premium Puzzle And Emotional Asset Pricing

Author

Listed:
  • MARC GÜRTLER

    (Department of Finance, Braunschweig University of Technology, Abt-Jerusalem-Str. 7, Braunschweig, Germany)

  • NORA HARTMANN

    (McKinsey & Company, Hamburg, Germany)

Abstract

Since the equity premium as well as the risk-free rate puzzle question the concepts central to financial and economic modeling, we apply behavioral decision theory to asset pricing in view of solving these puzzles. US stock market data for the period 1960–2003 and German stock market data for the period 1977–2003 show that emotional investors who act in accordance to Bell's [6] disappointment theory — a special case of prospect theory — and additionally administer mental accounts demand a high equity premium. Furthermore, these investors reason a low risk-free rate. However, Barberis et al. [5] already showed that limited rational investors demand a high equity premium. But as opposed to them, our approach additionally supports dividend smoothing.

Suggested Citation

  • Marc Gürtler & Nora Hartmann, 2007. "The Equity Premium Puzzle And Emotional Asset Pricing," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 10(06), pages 939-965.
    • Handle: RePEc:wsi:ijtafx:v:10:y:2007:i:06:n:s0219024907004500
    DOI: 10.1142/S0219024907004500
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    References listed on IDEAS

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    1. Brav, Alon & Graham, John R. & Harvey, Campbell R. & Michaely, Roni, 2005. "Payout policy in the 21st century," Journal of Financial Economics, Elsevier, vol. 77(3), pages 483-527, September.
    2. Rajnish Mehra, 2003. "The Equity Premium: Why is it a Puzzle?," NBER Working Papers 9512, National Bureau of Economic Research, Inc.
    3. Bryan R. Routledge & Stanley E. Zin, 2010. "Generalized Disappointment Aversion and Asset Prices," Journal of Finance, American Finance Association, vol. 65(4), pages 1303-1332, August.
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