A Bayesian solution to the equity premium puzzle
نویسنده
چکیده
This paper describes a Bayesian solution to the equity premium puzzle, that is, the inability of standard intertemporal economic models to account for the magnitude of the observed excess return earned by a risky security over the return on T-bills. We follow convention and assume a single representative agent, but the main difference is that we suppose that the agent is not certain about the parameters of the dividend process, modelling this uncertainty by a prior distribution, and making inferences in a Bayesian fashion. The price of the stock is still the NPV of future dividends, but the agent is now averaging not only over the possible future paths of the dividend process, but also over the parameters that govern its dynamics. We then use particle filtering to work out the posterior distribution of the parameters of the problem, and find a striking conclusion; coefficients of relative risk aversion lie in the interval (1,2) with high probability in other words, there is no equity premium puzzle. JEL Classification: G10, G12.
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