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Worst-case Robust Approach to the Equity Premium Puzzle

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Author Info

  • Nalan Gulpinar

    (Imperial College, UK)

  • Turalay Kenc

    (Imperial College, UK)

  • Berc Rustem

    (Imperial College, UK)

Abstract

The inability of standard intertemporal economic models under resonable values of the key parameters to generate the observed equity premium is termed as the equity premium puzzle. In order to resolve the puzzle, we propose a new approach based on worst-case analysis where agents make decisions under risk and uncertainty. The consumption investment problem faced by agents is then posed as a continuous min-max model. The min-max strategy provides a guaranteed optimal performance in view of continuum of scenarios, varying between upper and lower bounds, of asset price and dividend. The worst-case performance will improve if any other scenario other than the worst-case is realised. Our preliminary results show that the worst-case approach allivates the equity premium puzzle

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Bibliographic Info

Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2006 with number 514.

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Date of creation: 04 Jul 2006
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Handle: RePEc:sce:scecfa:514

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Keywords: consumption investment; equity premium; min-max; optimisation;

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