• Review of literature in two ways to show EPP is a real puzzle and the existing explanations are insufficient.
Is the post-1926 period special?
• Mehra & Prescott(1985)
• Since 1926, annual returns for stocks and TB are 7 % and less than 1 %
•
1% for T-B (real)
• Mehra and Prescott (1989) argue that it is difficult to explain
• coefficient of relative risk aversion
• 30 VS 1
• Why is the premium so large? • Why is anyone willing to hold bonds?
the bet played out.
• Samuelson’s theorem of irrationality:
• Rationale for turning down the bet:
• “Because I would feel $100 loss more than $200 gain”
• Mental accounting • aggregation rules are not neutral • Example: • 50% win $200 • 50% loss $100 • Whether you will accept such a bet?
• Turn down one bet • Accept two or more bets without watching
Premium 6.Do organization display myopic loss
aversion? 7.Conclusion
1.Introduction
• Discrepancy between returns on stocks and fixed income securities
• Since 1926 , 7 % for stocks (real)
• That is the Loss aversion.
Utility function (x is the change in wealth)
One bet: 200*0.5 – 2.5*100*0.5= -- 25
Two bets: 400*0.25+100*0.5-2.5*200*0.25=75
• The relevance to equity premium puzzle • Stock 7% return ,20% SD • Safe asset 1% return,0 SD(?) • The longer to hold the asset, the more
attractive the risky asset, only if the investment is not evaluated frequently
• Proposition: Myopic Loss aversion • Based on two concepts: • 1.Loss aversion (tendency to be more
sensitive to loss than gain) asymmetry of S-shaped value function • 2.mental accounting (implicit methods to code and evaluate financial outcomes)
Three bets: 600*0.125+300*0.375+0*0.375—
300*2.5*0.125= 93.75
• When preference is loss averse, they will be more willing to take risks if they evaluate performance infrequently
Myopic Loss Aversion and the Equity Premium Puzzle
1.Introduction 2.Is the Equity Premium Puzzle Real? 3.Prospect Theory and Loss Aversion 4.How often are portfolios evaluated? 5.Myopia and Magnitude of the Equity
• Two factors contribute to an investor being unwilling to hold equities:
• Loss aversion and short evaluation period • Which combines as • Myopic loss aversion.
• Can Mபைடு நூலகம்A explain the EPP?
• The hypothesis is plausible after various tests.
• How to do the tests?
• First, What combination of loss aversion and evaluation period is necessary to explain EPP?
• 2nd,How often to evaluate the portfolio in order to accept the EPP?
• 3rd,what combination of assets will be optimal with a given one-year period?
2.Is the Equity Premium Puzzle Real?