The equity premium puzzle and stochastic population

Abstract

This thesis aims to examine the link between the equity premium and demographic uncertainty. First I will present the theoretical background for the equity premium puzzle and overlapping generations models, before building an overlapping generations model; with two stochastic variables, population growth and technology. The model is a standard general equilibrium model, where agents maximize their objective functions, subject to some constraints. The stochastic variables are jointly log-normally distributed. Derivations are shown in detail to make it easy to read. Lastly I calibrate the model. The calibration shows that the stochastic population cannot account for the high equity premium. The results are similar to those of Mehra and Prescott (1985) and others, predicting that equity premium will be less than 1%.