The equity risk premium: a solved puzzle : an emperical study of the recursive utility model with estimates for the wealth portfolio

Abstract

In this thesis, we calibrate recursive utility models in discrete and continuous time, and find a range of plausible preference parameters for the utility discount rate (), the relative risk aversion and the elasticity of intertemporal substitution in consumption (EIS). When challenging the consumption-based asset pricing model based on expected utility with our collected data, we provide evidence for an ongoing equity premium puzzle in The United States. Our results indicate that deriving the risk-free rate and risk premium by using recursive utility, rather than expected utility, is a promising way to resolve the puzzle. We consider the market portfolio to be an unfavourable proxy for wealth, argued by the low stock participation as a consequence of inequality. Instead, we use our own estimates for the wealth portfolio.