The Equity Premium

Mehra, R., & Prescott, E. C. (1985). The Equity Premium: A Puzzle. Journal of Monetary Economics, 15(2), 145-161.

Type

Journal article

Intellectual base

Primary research

Year

1985

Volume

15

Issue

2

Pages

145-161

ISSN

0304-3932

DOI

10.1016/0304-3932(85)90061-3

DOI registrant

Elsevier

Link

https://doi.org/10.1016/0304-3932(85)90061-3

Cited from

behavioral_economics, economics_finance, physics

Cited by

6 citations across 6 artifacts.

Each citation links to the sentence it supports in the citing article.

Primes

• Calibration Anomaly
  • In finance the equity premium puzzle is the paradigm: a standard consumption model with reasonable risk aversion predicts a tiny risk premium while observation gives a large one, and the factor-of-sixty gap launched decades of theoretical work.

    This sourceStates the equity-premium puzzle: a consumption-based general-equilibrium model with plausible risk aversion predicts a premium far smaller than the historically observed one.

• Loss Aversion
  • explained the equity-premium puzzle (Mehra-Prescott 1985)

    This sourceDocuments that observed equity risk premia are too high for standard expected-utility equilibrium; foundational for equity-premium-puzzle literature and subsequent model extensions.

• Risk Aversion
  • The puzzle implies either that γ must be implausibly high (∼30+) or that the standard model omits critical structural features (rare disasters, habit formation, time-varying risk premiums)

    This sourceDocuments that observed long-run equity risk premia are far higher than standard CRRA consumption-based asset-pricing equilibrium predicts for plausible risk-aversion coefficients; foundational for the equity-premium-puzzle literature and subsequent model extensions.

• Risk–Return Tradeoff
  • foundational); the risk-return tradeoff is an equilibrium-market property arising from risk-averse investors aggregating. Not a complete model of return determination — even in its multi-factor extensions, systematic risk explains only part of the cross-sectional variation in returns; empirical pricing anomalies (momentum, value premium, low-volatility anomaly, quality premium) have motivated ongoing model extensions. Not universally validated empirically — the equity-premium puzzle (Mehra-Prescott

    This sourceDocuments that observed equity risk premia are too high for standard expected-utility equilibrium; foundational for equity-premium-puzzle literature and subsequent model extensions.

Domain-specific

• Ellsberg Paradox
  • Historically, US equities have returned several percentage points more per year than safe government bonds — a gap too large to explain by plausible risk aversion over the known variance of stock returns alone (Mehra and Prescott, 1985).
• Equity premium puzzle
  • The equity premium puzzle is the observation, formalized by Rajnish Mehra and Edward Prescott in 1985, that the historical excess return of US equities over short-term government bonds — averaging roughly 6 percentage points per year over the 1889–1978 period — is an order of magnitude larger than what a standard consumption-based asset-pricing model can rationalize given plausible values of risk aversion

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