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A Note on the McGrattan and Prescott (2003) Adjustments and the Equity Premium Puzzle

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Author Info
Selahattin Imrohoroglu (USC)

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Abstract

McGrattan and Prescott (2003) argue that the average equity premium is less than one percent when the annual data used in the computation are adjusted in certain ways: equity returns reduced by subtracting diversification costs and taxes on dividend yields, and debt yields are raised by using long-term debt (instead of 90-day T-Bills) and ignoring the 1935-1960 period of government regulation of the financial sector. This note takes the adjusted measurements proposed by McGrattan and Prescott (2003) and subjects them to statistical tests in an attempt to examine the equity premium puzzle. The findings suggest that using their series solves the `average equity premium' puzzle but the `low risk-free rate' and `excess volatility' puzzles remain as challenges to standard theory.

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Paper provided by EconWPA in its series Macroeconomics with number 0402009.

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Length: 12 pages
Date of creation: 04 Feb 2004
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Handle: RePEc:wpa:wuwpma:0402009

Note: Type of Document - pdf; prepared on Win2000; pages: 12
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E - Macroeconomics and Monetary Economics

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    Other versions:
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  3. Ellen R. McGrattan & Edward C. Prescott, 2003. "Average Debt and Equity Returns: Puzzling?," American Economic Review, American Economic Association, vol. 93(2), pages 392-397, May. [Downloadable!]
    Other versions:
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    Other versions:
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  9. John Y. Campbell & John Cochrane, 1999. "Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," Journal of Political Economy, University of Chicago Press, vol. 107(2), pages 205-251, April. [Downloadable!] (restricted)
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