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Survival Bias and the Equity Premium Puzzle

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  • Haitao Li
  • Yuewu Xu

Abstract

Previous authors have raised the concern that there could be serious survival bias in the observed U.S. equity premium. Contrary to conventional wisdom, we argue that the survival bias in the U.S. data is unlikely to be significant. To reach this conclusion, we introduce a general framework for modeling survival and derive a mathematical relationship between the ex ante survival probability and the average survival bias. This relationship reveals the fundamental difficulty facing the survival argument: High survival bias requires an ex ante probability of market failure, which seems unrealistically high given the history of world financial markets.

Suggested Citation

  • Haitao Li & Yuewu Xu, 2002. "Survival Bias and the Equity Premium Puzzle," Journal of Finance, American Finance Association, vol. 57(5), pages 1981-1995, October.
    • Handle: RePEc:bla:jfinan:v:57:y:2002:i:5:p:1981-1995
    DOI: 10.1111/0022-1082.00486
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    Cited by:

    1. Kaustia, Markku & Lehtoranta, Antti & Puttonen, Vesa, 2013. "Does sophistication affect long-term return expectations? Evidence from financial advisers' exam scores," SAFE Working Paper Series 3, Leibniz Institute for Financial Research SAFE.
    2. Bhanot, Karan, 2005. "What causes mean reversion in corporate bond index spreads? The impact of survival," Journal of Banking & Finance, Elsevier, vol. 29(6), pages 1385-1403, June.
    3. Marco Taboga, 2002. "The Realized Equity Premium has been Higher than Expected: Further Evidence," CeRP Working Papers 29, Center for Research on Pensions and Welfare Policies, Turin (Italy).
    4. Fernandez, Pablo, 2004. "Are calculated betas good for anything?," IESE Research Papers D/555, IESE Business School.
    5. Campbell, John Y., 2003. "Consumption-based asset pricing," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 13, pages 803-887, Elsevier.
    6. Prat, Georges, 2013. "Equity risk premium and time horizon: What do the U.S. secular data say?," Economic Modelling, Elsevier, vol. 34(C), pages 76-88.
    7. Geoffrey J. Warren, 2008. "Implications for Asset Pricing Puzzles of a Roll‐over Assumption for the Risk‐Free Asset," International Review of Finance, International Review of Finance Ltd., vol. 8(3‐4), pages 125-157, September.
    8. Ritter, Jay R., 2005. "Economic growth and equity returns," Pacific-Basin Finance Journal, Elsevier, vol. 13(5), pages 489-503, November.
    9. Fernandez, Pablo, 2006. "The equity premium in finance and valuation textbooks," IESE Research Papers D/657, IESE Business School.
    10. Michele Bagella & Leonardo Becchetti & Rocco Ciciretti, 2007. "Earning Forecast Error in US and European Stock Markets," The European Journal of Finance, Taylor & Francis Journals, vol. 13(2), pages 105-122.
    11. Fernandez, Pablo, 2005. "La prima de riesgo del mercado (market risk premium)," IESE Research Papers D/585, IESE Business School.
    12. Fernandez, Pablo, 2004. "Market risk premium: Required, historical and expected," IESE Research Papers D/574, IESE Business School.

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