The Equity Premium: It’s Still a Puzzle

The paper examines the literature that attempts to resolve the equity premium and risk free rate puzzles. It demonstrates that the puzzles will confront any model of asset prices that relies on three crucial assumptions: preferences have a particular parametric form, asset markets are complete, and asset trade is frictionless. A survey of the literature that relaxes these assumptions reveals that there are now several plausible explanations of the seemingly low risk free rate, but the large size of the equity premium remains a puzzle.

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