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The Equity Premium Puzzle: A Review

  • Rajnish Mehra 1

[1]Rajnish Mehra, Department of Economics, University of California, mehra@econ.ucsb.edu

Short description

The Equity Premium Puzzle offers a birds-eye view of the literature explained by one of the authors of the pioneering work in this area. This is must reading for all students and scholars of finance and macroeconomics.

Keywords

Equity premium, Investment risk, Capital markets, Asset prices

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Table of contents

1 Introduction
2 Empirical Facts
3 Is the Equity Premium a Premium for Bearing Non-diversifiable Risk?
4 Risk Based Explanations of the Equity Premium
5 Non-Risk Based Explanations of the Equity Premium
6 Concluding Comments
Appendix
Acknowledgments
References

Foundations and Trends® in Finance

(Vol 2, Issue 1, 2006, pp 1-81)

DOI: 10.1561/0500000006

Abstract

Over two decades ago, Mehra and Prescott (1985) challenged the finance profession with a poser: the historical US equity premium is an order of magnitude greater than can be rationalized in the context of the standard neoclassical paradigm of financial economics. This regularity, dubbed "the equity premium puzzle," has spawned a plethora of research efforts to explain it away. In this review, the author takes a retrospective look at the original paper and explains the conclusion that the equity premium is not a premium for bearing non-diversifiable risk.

Table of contents

Introduction
Empirical Facts
Is the Equity Premium a Premium for Bearing Non-diversifiable Risk?
Risk Based Explanations of the Equity Premium
Non-risk Based Explanations of the Equity Premium
Concluding Comments
References
Cover image for The Equity Premium Puzzle

The Equity Premium Puzzle:

A Review

88 pages

DOI: 10.1561/9781601980656

E-ISBN: 978-1-60198-065-6

ISBN: 978-1-60198-064-9

Description

The Equity Premium Puzzle reviews the literature on this phenomenon from the original papers by Mehra and Prescott to the present. The author shows that the equity premium – the return earned by a broad market index in excess of that earned by a relatively risk-free security – is not a premium for bearing non-diversifiable risk. The Equity Premium Puzzle documents the historical equity premium in the United States and in selected countries with significant capital markets, examines the question, 'Is the equity premium a premium for bearing non-diversifiable risk?', addresses risk and preference based explanations of the equity premium, and reviews the nascent literature that takes as given the findings in Mehra and Prescott (1985) and tries to account for the equity premium by factors other than aggregate risk. The Equity Premium Puzzle offers a birds-eye view of the literature explained by one of the authors of the pioneering work in this area. This is must reading for all students and scholars of finance and macroeconomics.