Editing Equity premium puzzle (section)

==Description==
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The term was coined by [[Rajnish Mehra]] and [[Edward C. Prescott]] in a study published in 1985 titled "The Equity Premium: A Puzzle".<ref>{{cite journal |last1=Mehra |first1=Rajnish |last2=Prescott |first2=Edward C. |title=The equity premium: A puzzle |journal=Journal of Monetary Economics |date=March 1985 |volume=15 |issue=2 |pages=145–161 |doi=10.1016/0304-3932(85)90061-3 |url=http://minneapolisfed.org/research/sr/sr81.pdf }}</ref> An earlier version of the paper was published in 1982 under the title "A test of the intertemporal asset pricing model". The authors found that a standard general equilibrium model, calibrated to display key U.S. business cycle fluctuations, generated an equity premium of less than 1% for reasonable risk aversion levels. This result stood in sharp contrast with the average equity premium of 6% observed during the historical period.

In 1982, [[Robert J. Shiller]] published the first calculation that showed that either a large risk aversion coefficient or counterfactually large consumption variability was required to explain the means and variances of asset returns.<ref>{{cite journal |last1=Shiller |first1=Robert J. |title=Consumption, asset markets, and macroeconomic fluctuations |journal=Carnegie-Rochester Conference Series on Public Policy |date=January 1982 |volume=17 |pages=203–238 |doi=10.1016/0167-2231(82)90046-X |s2cid=154356695 |url=http://www.nber.org/papers/w0838.pdf }}</ref> Azeredo (2014) shows, however, that increasing the risk aversion level may produce a negative equity premium in an [[Arrow–Debreu model|Arrow-Debreu economy]] constructed to mimic the persistence in U.S. consumption growth observed in the data since 1929.<ref name=Azeredo2014>{{cite journal |last=Azeredo |first=F. |year=2014 |title=The equity premium: a deeper puzzle |journal=Annals of Finance |volume=10 |issue=3 |pages=347–373 |doi=10.1007/s10436-014-0248-7 |s2cid=7108921 |url=http://www.escholarship.org/uc/item/6ks5p6v5 }}</ref>

The intuitive notion that stocks are much riskier than bonds is not a sufficient explanation of the observation that the magnitude of the disparity between the two returns, the equity [[risk premium]] (ERP), is so great that it implies an implausibly high level of investor risk aversion that is fundamentally incompatible with other branches of economics, particularly [[macroeconomics]] and [[financial economics]].

The process of calculating the equity risk premium, and selection of the data used, is highly subjective to the study in question, but is generally accepted to be in the range of 3–7% in the [[Long run and short run|long-run]]. Dimson et al. calculated a premium of "around 3–3.5% on a geometric mean basis" for global equity markets during 1900–2005 (2006).<ref>{{cite book |last1=Dimson |first1=Elroy |last2=Marsh |first2=Paul |last3=Staunton |first3=Mike |chapter=The Worldwide Equity Premium: A Smaller Puzzle |year=2008 |title=Handbook of the Equity Risk Premium |location=Amsterdam |publisher=Elsevier |ssrn=891620 |isbn=978-0-08-055585-0 }}</ref> However, over any one decade, the premium shows great variability—from over 19% in the 1950s to 0.3% in the 1970s.

In 1997, Siegel found that the actual standard deviation of the 20-year rate of return was only 2.76%. This means that for long-term investors, the risk of holding the stock of a smaller than expected can be derived only by looking at the standard deviation of annual earnings. For long-term investors, the actual risks of fixed-income securities are higher. Through a series of reasoning, the equity premium should be negative.<ref>{{cite journal |last1=Siegel |first1=Jeremy J |last2=Thaler |first2=Richard H |title=Anomalies: The Equity Premium Puzzle |journal=Journal of Economic Perspectives |date=1 February 1997 |volume=11 |issue=1 |pages=191–200 |doi=10.1257/jep.11.1.191 }}</ref>

To quantify the level of risk aversion implied if these figures represented the ''expected'' outperformance of equities over bonds, investors would prefer a certain payoff of $51,300 to a 50/50 bet paying either $50,000 or $100,000.<ref>{{cite journal |journal=[[Journal of Financial Economics]] |volume=29 |issue=1 |year=1991 |pages=97–112 |title=The Consumption of Stockholders and Nonstockholders |first1=N. Gregory |last1=Mankiw |first2=Stephen P. |last2=Zeldes |doi=10.1016/0304-405X(91)90015-C |citeseerx=10.1.1.364.2730 |s2cid=3084416 }}</ref>

The puzzle has led to an extensive research effort in both macroeconomics and finance. So far a range of useful theoretical tools and numerically plausible explanations have been presented, but no one solution is generally accepted by economists.