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Myopic Loss Aversion, the Equity Premium Puzzle, and GARCH

  • Ågren, Martin

    (Department of Economics)

This paper concerns the distributional assumptions made on stock returns in the myopic loss aversion (MLA) proposed explanation to the equity premium puzzle. While Benartzi and Thaler (1995) assume temporal independence in these returns, we introduce a more realistic assumption incorporating conditional heteroskedasticity. This involves the work on temporal aggregation of GARCH processes of Drost and Nijman (1993). Using Swedish data, our estimation method produces an overall larger evaluation period than the one originally obtained by Benartzi and Thaler, e.g., over the sample period July 1961 through December 2003 the evaluation period increases from 12 to 17. This shows that MLA indeed can explain a large equity premium but, also, that the model is sensitive to the distributional assumption made on stock returns.

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Paper provided by Uppsala University, Department of Economics in its series Working Paper Series with number 2005:11.

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Length: 34 pages
Date of creation: 21 Jan 2005
Date of revision:
Handle: RePEc:hhs:uunewp:2005_011
Contact details of provider: Postal: Department of Economics, Uppsala University, P. O. Box 513, SE-751 20 Uppsala, Sweden
Phone: + 46 18 471 25 00
Fax: + 46 18 471 14 78
Web page: http://www.nek.uu.se/
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  1. John List & Michael Haigh, 2005. "Do professional traders exhibit myopic loss aversion? An experimental analysis," Artefactual Field Experiments 00052, The Field Experiments Website.
  2. Shlomo Benartzi & Richard H. Thaler, 1993. "Myopic Loss Aversion and the Equity Premium Puzzle," NBER Working Papers 4369, National Bureau of Economic Research, Inc.
  3. Kocherlakota, N., 1995. "The Equity Premium: It's Still a Puzzle," Working Papers 95-05, University of Iowa, Department of Economics.
  4. Richard H. Thaler, 2008. "Mental Accounting and Consumer Choice," Marketing Science, INFORMS, vol. 27(1), pages 15-25, 01-02.
  5. Durand, Robert B. & Lloyd, Paul & Wee Tee, Hong, 2004. "Myopic loss aversion and the equity premium puzzle reconsidered," Finance Research Letters, Elsevier, vol. 1(3), pages 171-177, September.
  6. 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.
  7. Drost, F.C. & Nijman, T.E., 1993. "Temporal aggregation of GARCH processes," Other publications TiSEM 0642fb61-c7f4-4281-b484-4, Tilburg University, School of Economics and Management.
  8. Constantinides, George M, 1990. "Habit Formation: A Resolution of the Equity Premium Puzzle," Journal of Political Economy, University of Chicago Press, vol. 98(3), pages 519-43, June.
  9. Drost, F.C. & Nijman, T.E., 1990. "Temporal Aggregation Of Garch Processes," Papers 9066, Tilburg - Center for Economic Research.
  10. repec:ner:tilbur:urn:nbn:nl:ui:12-153273 is not listed on IDEAS
  11. Gul, Faruk, 1991. "A Theory of Disappointment Aversion," Econometrica, Econometric Society, vol. 59(3), pages 667-86, May.
  12. Nicholas Barberis & Ming Huang & Tano Santos, 1999. "Prospect Theory and Asset Prices," NBER Working Papers 7220, National Bureau of Economic Research, Inc.
  13. Andrew Ang & Geert Bekaert & Jun Liu, 2000. "Why Stocks May Disappoint," NBER Working Papers 7783, National Bureau of Economic Research, Inc.
  14. Tim Bollerslev, 1986. "Generalized autoregressive conditional heteroskedasticity," EERI Research Paper Series EERI RP 1986/01, Economics and Econometrics Research Institute (EERI), Brussels.
  15. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
  16. Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
  17. Thaler, Richard H, et al, 1997. "The Effect of Myopia and Loss Aversion on Risk Taking: An Experimental Test," The Quarterly Journal of Economics, MIT Press, vol. 112(2), pages 647-61, May.
  18. Gneezy, U. & Kapteyn, A. & Potters, J.J.M., 2002. "Evaluation Periods and Asset Prices in a Market Experiment," Discussion Paper 2002-8, Tilburg University, Center for Economic Research.
  19. Fama, Eugene F & French, Kenneth R, 1988. "Permanent and Temporary Components of Stock Prices," Journal of Political Economy, University of Chicago Press, vol. 96(2), pages 246-73, April.
  20. Friend, Irwin & Blume, Marshall E, 1975. "The Demand for Risky Assets," American Economic Review, American Economic Association, vol. 65(5), pages 900-922, December.
  21. Lamoureux, Christopher G & Zhou, Guofu, 1996. "Temporary Components of Stock Returns: What Do the Data Tell Us?," Review of Financial Studies, Society for Financial Studies, vol. 9(4), pages 1033-59.
  22. Jeremy J. Siegel & Richard H. Thaler, 1997. "Anomalies: The Equity Premium Puzzle," Journal of Economic Perspectives, American Economic Association, vol. 11(1), pages 191-200, Winter.
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