Exact Solutions for Expected Rates of Return under Markov Regime Switching: Implications for the Equity Premium Puzzle
This paper derives simple closed-form solutions for expected rates of return on stocks and riskless one-period bills under the assumption that shocks to the growth rates of consumption and dividends are generated by a Markov regime-switching process. These closed-form solutions are used to show that the Markov regime-switching process exacerbates the equity premium puzzle and the risk-free rate puzzle. Three empirical examples illustrate the magnitude of the effects of Markov regime switching on equilibrium expected returns.
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Volume (Year): 26 (1994)
Issue (Month): 3 (August)
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References listed on IDEAS
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- Phillippe Weil, 1997.
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Levine's Working Paper Archive
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- S.G. Cecchetti & P. Lam & N.C. Mark, 2010. "The equity premium and the risk-free rate: matching the moments," Levine's Working Paper Archive 1396, David K. Levine.
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- Stephen G. Cecchetti & Pok-sang Lam & Nelson C. Mark, 1988.
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