Editing Equity premium puzzle (section)

=== Market failure explanations ===

Two broad classes of [[market failure]] have been considered as explanations of the equity premium.

First, problems of [[adverse selection]] and [[moral hazard]] may result in the absence of markets in which individuals can insure themselves against systematic risk in labor income and noncorporate profits.

Second, [[transaction cost]]s or liquidity constraints may prevent individuals from [[consumption smoothing|smoothing consumption over time]]. In relation to transaction costs, there are significantly greater costs associated with trading stocks than trading bonds.<ref>{{cite journal |last1=Kocherlakota |first1=Narayana R. |title=The Equity Premium: It's Still a Puzzle |journal=Journal of Economic Literature |volume=34 |issue=1 |pages=42 and 71|citeseerx=10.1.1.334.8403 }}</ref> These include costs to acquire information, broker fees, taxes, load fees and the bid-ask spread.<ref name="The Equity Premium: It's Still a Pu">{{cite journal |last1=Kocherlakota |first1=Narayana R. |title=The Equity Premium: It's Still a Puzzle |journal=Journal of Economic Literature |volume=34 |issue=1 |pages=42 and 71 |citeseerx=10.1.1.334.8403 }}</ref> As such, when shareholders attempt to capitalise on the equity premium by  adjusting their asset allocation and purchasing more stocks, they incur significant trading costs which eliminate the gains from the equity premium.<ref name="The Equity Premium: It's Still a Pu"/> However, Kocherlakota (1996) contends that there is insufficient evidence to support this proposition and further data about the size and sources of trading costs need to be collected before this proposition could be validated.<ref name="The Equity Premium: It's Still a Pu"/>