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Estimation Uncertainty and the Equity Premium

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  • HONG YAN

Abstract

This paper studies a dynamic equilibrium model of asset prices in a partially observable exchange economy. It shows that the precautionary savings motive in response to estimation uncertainty can dominate the risk aversion effect, resulting in the reduction of the equity premium over short horizons. This exacerbates the equity premium puzzle. Over longer holding horizons, however, estimation uncertainty does induce higher risk premiums on equity over risk‐free coupon bonds of matching maturities, as long‐term bond yields are lowered due to the precautionary savings effect.

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  • Hong Yan, 2009. "Estimation Uncertainty and the Equity Premium," International Review of Finance, International Review of Finance Ltd., vol. 9(3), pages 243-268, September.
    • Handle: RePEc:bla:irvfin:v:9:y:2009:i:3:p:243-268
    DOI: 10.1111/j.1468-2443.2009.01090.x
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    Cited by:

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    2. Jing Tian & Qing Zhou, 2018. "Improving equity premium forecasts by incorporating structural break uncertainty," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 58(S1), pages 619-656, November.

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