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Equity Premium Puzzle: Literature Review and the Czech Data
Thesis title in Czech: Záhada prémie vlastního kapitálu: přehled literatury a česká data
Thesis title in English: Equity Premium Puzzle: Literature Review and the Czech Data
Key words: Záhada prémie základního kapitálu, modely oceňování pomocí spotřeby, bezriziková výnosová míra, koeficient averze k riziku, Česká republika
English key words: Equity premium puzzle, consumption based asset pricing, risk-free rate puzzle, risk aversion, time separable preferences, Czech Republic
Academic year of topic announcement: 2010/2011
Thesis type: diploma thesis
Thesis language: angličtina
Department: Institute of Economic Studies (23-IES)
Supervisor: doc. Ing. Tomáš Cahlík, CSc.
Author: hidden - assigned by the advisor
Date of registration: 09.06.2011
Date of assignment: 09.06.2011
Date and time of defence: 30.01.2013 00:00
Venue of defence: IES
Date of electronic submission:03.01.2013
Date of proceeded defence: 30.01.2013
Opponents: doc. Bc. Jiří Novák, M.Sc., Ph.D.
URKUND check:
Campbell, J.Y.: “Asset Prices, Consumption and the Business Cycle”, NBER Working Paper No. 6485, March 1998

Constantinides, G.M.: “Habit Formation: A Resolution of the Equity Premium Puzzle”, Journal of Political Economy, Vol.98, No.3, 1990

Dimson, E., P. Marsh, and M. Staunton: “The Worldwide Equity Premium: A Smaller Puzzle”, Handbook of the Equity Risk Premium, Elsevier, Amsterdam, 2008

Fama, E. and K. French: “The Equity Premium”, Journal of Finance, Vol. 57, 2002

Kocherlakota, N.R.: “The Equity Premium: It’s Still a Puzzle”, Journal of Economic Literature 34, 1996

Mehra, R.: “The Equity Premium: Why is it a Puzzle?”, Financial Analysts Journal, Vol. 59, 2003

Mehra, R.: “The Equity Premium: What Have we Learned in 20 years?” in R.Mehra, ed., Handbook of the Equity Risk Premium, Elsevier, Amsterdam, 2008

Mehra, R. and E.C. Prescott: “The Equity Premium: A Puzzle”, Journal of Monetary Economics, 1985

Ritter, J.: “Economic Growth and Equity Returns”, Pacific-Basin Finance Journal, Vol. 13, No.5, 2005

Weil, P.: ”The Equity Premium Puzzle and the Riskfree Rate Puzzle”, NBER Working Paper No.2829, January 1989

Welch, I.: “Views of Financial Economists on the Equity Premium and Other Issues”, Journal of Business, Vol.73, 2000
Preliminary scope of work in English
Equity Premium Puzzle was first described by Mehra and Prescott in their influential article “The Equity Premium: A Puzzle” in Journal of Monetary Economics, 1985. The topic relates to empirically observed excess return of stocks over government bonds which are taken as proxy for a risk free rate of return. The word “puzzle” is used due to implausibly high risk aversion coefficient, which is needed to explain the observed difference. As the result of Mehra and Prescott’s model doesn’t comply with reality, several authors then tried to reconcile this puzzle with different modifications to assumptions, models and econometric techniques used. These include time non-separability of utility function, habit formation of the representative agent, models with heterogeneous agents or relaxing the assumptions of rational expectations.

I would like to elaborate this master thesis (as the title suggests) in two parts. In the first part I want to describe the developments regarding the estimation of the so called equity premium puzzle, discuss the shortcomings of the original model as well as the benefits and drawbacks of suggested resolutions. In second part, I want to estimate the phenomena using Czech data, using the original Mehra and Prescott model as a benchmark model to see whether the puzzle is present. Then I would employ some of the adjusted models (such as Weil (1989) or Constantinides (1990)) to see whether these suggested modifications help to resolve the puzzle in the Czech dataset.
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