EXPLAINING THE EQUITY RISK PREMIUM

Authors

  • LAURIAN LUNGU,

    1. Cardiff Business School
    Search for more papers by this author
  • PATRICK MINFORD

    1. Cardiff Business School and CEPR
    Search for more papers by this author
    •  

      We thank Laurence Copeland, Max Gillman, David Peel, other Cardiff economics seminar participants and two anonymous referees for helpful comments and suggestions. We also thank David Meenagh for his assistance.


  • Manuscript received 19.12.03; final version received 30.6.05.

Abstract

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.

Ancillary