The efficient index hypothesis and its implications in the BSM model
AbstractThis note studies the behavior of an index I_t which is assumed to be a tradable security, to satisfy the BSM model dI_t/I_t = \mu dt + \sigma dW_t, and to be efficient in the following sense: we do not expect a prespecified trading strategy whose value is almost surely always nonnegative to outperform the index greatly. The efficiency of the index imposes severe restrictions on its growth rate; in particular, for a long investment horizon we should have \mu\approx r+\sigma^2, where r is the interest rate. This provides another partial solution to the equity premium puzzle. All our mathematical results are extremely simple.
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Bibliographic InfoPaper provided by arXiv.org in its series Papers with number 1109.2327.
Date of creation: Sep 2011
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Web page: http://arxiv.org/
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-09-22 (All new papers)
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- R. Mehra & E. Prescott, 2010.
"The equity premium: a puzzle,"
Levine's Working Paper Archive
1401, David K. Levine.
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