Editing Equity premium puzzle (section)

{{short description|Economics concept}}

The '''equity premium puzzle''' refers to the inability of an important class of [[economic model]]s to explain the average '''equity risk premium''' ('''ERP''') provided by a diversified portfolio of [[equities]] over that of [[government bond]]s, which has been observed for more than 100 years. There is a significant disparity between returns produced by stocks compared to returns produced by government treasury bills.<ref name="Equity Premium Puzzle">{{cite web |last1=Kenton |first1=Will |title=Equity Premium Puzzle |url=https://www.investopedia.com/terms/e/epp.asp |website=Investopedia |access-date=30 April 2022}}</ref> The equity premium puzzle addresses the difficulty in understanding and explaining this disparity.<ref name="Equity Premium Puzzle"/> This disparity is calculated using the equity [[risk premium]]:

The equity risk premium is equal to the difference between equity returns and returns from government bonds. It is equal to around 5% to 8% in the United States.<ref>{{cite web |last1=Kenton |first1=Will |title=Equity Premium Puzzle |url=https://www.investopedia.com/terms/e/epp.asp |publisher=Investopedia |access-date=30 April 2022}}</ref>

The risk premium represents the compensation awarded to the equity holder for taking on a higher risk by investing in equities rather than government bonds.<ref name="Equity Premium Puzzle"/> However, the 5% to 8% premium is considered to be an implausibly high difference and the equity premium puzzle refers to the unexplained reasons driving this disparity.<ref>{{cite web |last1=Kenton |first1=Will |title=Equity Premium Puzzle |url=https://www.investopedia.com/terms/e/epp.asp |website=Investopedia }}</ref>