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Risk Based Explanations of the Equity Premium

Listed author(s):
  • John Donaldson
  • Rajnish Mehra

This essay reviews the family of models that seek to provide aggregate risk based explanations for the empirically observed equity premium. Theories based on non-expected utility preference structures, limited financial market participation, model uncertainty and the small probability of enormous losses are detailed. We impose the additional requirements that candidate models yield consistent inter temporal portfolio choice and that a representative agent can be constructed which is independent of the underlying heterogeneous economy's initial wealth distribution. While many models are able to replicate a wide variety of financial statistics including the premium, few satisfy these latter criteria as well.

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File URL: http://www.nber.org/papers/w13220.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13220.

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Date of creation: Jul 2007
Publication status: published as “Risk Based Explanations of the Equity Premium” (with J.B Donaldson) Handbook of Investments: The Handbook of the Equity Risk Premium. ed. by Rajnish Mehra, Elsevier, Amsterdam, 2008, pp 37- 100.
Handle: RePEc:nbr:nberwo:13220
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