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Finance & Accounting
Pages 5 (1255 words)
Name: Instructor: Course: Date: Equity Premium Puzzle Introduction In a pure exchange economy with homogenous consumers, every consumer maximizes the same utility function, which represents the usefulness of commodities to satisfy human wants. Stochastic behavior of equilibrium asset prices in such an economy is clearly exhibited using representative agent models of assets returns in which per capita consumption is correlated with the consumption stream of typical investors…
Financial markets analysis shows those equity premiums puzzle still remain a reality with modifications to the assumed preferences and imperfections in the model of risk aversion. There have been some difficulties in the calibration used in the analysis and existence of a substantial equity premium (Lucas 1429). Equity premium and risk free rate puzzles The value premium states that for possible qualities of the danger repugnance coefficient, the contrast of the needed rate of profit for money markets and the riskless rate of premium is too huge, given the watched minor fluctuation of the development rate of capitalization. This puzzle is resolved in the wider context of an economy with rational expectations once the separable time preference is relaxed to allow adjacent complementarities in consumption. On the other hand, given that a large equity premium implies that investors get a high risk; the standard models of preferences in turn imply that they do not like growth that much. ...
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