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Explaining The Equity Risk Premium

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  • LAURIAN LUNGU
  • PATRICK MINFORD

Abstract

We develop a simple overlapping generations model in which the young have a choice in investing in equities or index‐linked bonds. Projections of share price uncertainty over a 30‐year period show that the risk associated with such long‐term investments predicts an equity premium that matches historical values. Moreover, we calibrate the model and show that it can predict up to the fourth moment of both the observed risk premium and the real rate of interest.

Suggested Citation

  • Laurian Lungu & Patrick Minford, 2006. "Explaining The Equity Risk Premium," Manchester School, University of Manchester, vol. 74(6), pages 670-700, December.
  • Handle: RePEc:bla:manchs:v:74:y:2006:i:6:p:670-700
    DOI: 10.1111/j.1467-9957.2006.00522.x
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    File URL: https://doi.org/10.1111/j.1467-9957.2006.00522.x
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    1. Hatcher, Michael, 2014. "Indexed versus nominal government debt under inflation and price-level targeting," Journal of Economic Dynamics and Control, Elsevier, vol. 45(C), pages 126-145.

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    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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