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EQUITY Premium Puzzle in a Data-Rich Environment

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  • Douch, Mohamed
  • Bouaddi, Mohammed

Abstract

Standard consumption-based asset pricing models focus on the consumption risk, seen as the only source of fluctuations and information about risk for the informed investor. These models, however, can account for high expected excess stock return only when assuming implausible relative risk aversion. This paper adds additional risk factors to the standard C-CAPM model to resolve both the equity premium and the risk-free rate puzzles as well as the risk-free rate volatility puzzle. By adding other relevant risk factors, the resulting pricing model is able to explain these puzzles relying on admissible range of local relative risk aversion. The model generates, also, a time-varying relative risk aversion and intertemporal elasticity of substitution.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 29440.

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Date of creation: Dec 2010
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Handle: RePEc:pra:mprapa:29440

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Keywords: Common factors; factor analysis; principal components; asset pricing; equity premium puzzle; risk free rate puzzle.;

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