Premium
EXPLAINING THE EQUITY RISK PREMIUM *
Author(s) -
LUNGU LAURIAN,
MINFORD PATRICK
Publication year - 2006
Publication title -
the manchester school
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.361
H-Index - 42
eISSN - 1467-9957
pISSN - 1463-6786
DOI - 10.1111/j.1467-9957.2006.00522.x
Subject(s) - economics , equity premium puzzle , risk premium , bond , equity (law) , econometrics , financial economics , equity risk , liquidity premium , volatility risk premium , index (typography) , interest rate , monetary economics , volatility (finance) , finance , private equity , market liquidity , liquidity risk , volatility smile , world wide web , political science , computer science , law
We develop a simple overlapping generations model in which the young have a choice in investing in equities or index‐linked bonds. Projections of share price uncertainty over a 30‐year period show that the risk associated with such long‐term investments predicts an equity premium that matches historical values. Moreover, we calibrate the model and show that it can predict up to the fourth moment of both the observed risk premium and the real rate of interest.