The Equity Premium Puzzle: Can Income Help?

In this paper we argue that implementing the income in the utility function can considerably contribute to the explanation of the equity premium puzzle. Macroeconomic data from developed and developing countries provides support to this idea. We propose a utility function that includes consumption, income and disentangles dividends as a specific form of income, and price assets using a consumption based asset pricing model based on the utility function. Empirical tests show that the predicted values of risk free return and equity premium are close to the historically observed ones.