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The Equity Premium Puzzle and the Riskfree Rate Puzzle

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  • Philippe Weil

Abstract

This paper studies the implications for general equilibrium asset pricing of a recently introduced class of Kreps-Porteus non-expected utility preferences, which is characterized by a constant intertemporal elasticity of substitution and a constant, but unrelated, coefficient of relative risk aversion. It is shown that the solution to the "equity premium puzzle" documented by Mehra and Prescott [19851 cannot be found, for plausibly calibrated parameter values, by simply separating risk aversion from intertemporal substitution. Rather, relaxing the parametric restriction on tastes implicit in the time-addictive expected utility specification and adopting Kreps-Porteus preferences in the direction of "more realism" is likely to add a "riskfree rate puzzle" to Mehra's and Prescott's "equity premium puzzle."

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  • Philippe Weil, 1989. "The Equity Premium Puzzle and the Riskfree Rate Puzzle," NBER Working Papers 2829, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:2829
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    1. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
    2. Mankiw, N Gregory & Shapiro, Matthew D, 1986. "Risk and Return: Consumption Beta versus Market Beta," The Review of Economics and Statistics, MIT Press, vol. 68(3), pages 452-459, August.
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