Since equity premium puzzle had long been a problem, many economists tried to give reasonable interpretations to the puzzle. I focus on the type of theories using bounded rationality as the answer to the problem. I am willing to find out that whether the puzzle still exists in recent decades. If it does exist, are the theories of bounded rationality still able to explain the puzzle? In the beginning, I introduce two theories referring to bounded rationality. Afterwards, I empirically analyze the data of the U.S., Japan and Euro-area by using a simpler model based on rationality. Interestingly, circumstances vary a lot from country to country. One theory may be suitable for one country but not for the others. Even so, the “suitable” theory fails to completely explain the whole tendency of variation during the observed period in the country. In the future, we still need to explore in depth of the puzzle.

Eidgen. Techn. Hochschule, Diss.--Zürich, 2006. / Zsfassung in dt. Sprache.

This thesis examines the financing and construction arrangements of the recently designed Airport Link project in Brisbane, Australia. The central hypothesis of the thesis is that the equity risk premium, combined with the public nature of toll roads, makes private financing of this kind of public infrastructure undesirable. It attempts to test this hypothesis by valuing the project under standard CAPM and WACC frameworks, and then modelling the sensitivity of the project’s value to different assumptions regarding traffic flows, inflation, asset risk, and errors in operating-cost forecasts. The results show that with large equity contributions the project is inherently unstable and given the finance structure, was always susceptible to a downward price spiral of the type observed. The thesis then models the project value under a public finance option and concludes that this is a more beneficial option for investors, the government, and the community alike.

This thesis examines the financing and construction arrangements of the recently designed Airport Link project in Brisbane, Australia. The central hypothesis of the thesis is that the equity risk premium, combined with the public nature of toll roads, makes private financing of this kind of public infrastructure undesirable. It attempts to test this hypothesis by valuing the project under standard CAPM and WACC frameworks, and then modelling the sensitivity of the project’s value to different assumptions regarding traffic flows, inflation, asset risk, and errors in operating-cost forecasts. The results show that with large equity contributions the project is inherently unstable and given the finance structure, was always susceptible to a downward price spiral of the type observed. The thesis then models the project value under a public finance option and concludes that this is a more beneficial option for investors, the government, and the community alike.

No / This paper shows that the presence of persistent uninsurable risk concentrated in economic depressions has the potential to resolve two well¿known asset pricing puzzles. It is also shown that the presence of such risk in more normal economic expansions and recessions is likely to be much less relevant in determining equilibrium asset prices.

[pt] Uma possível razão para a alta acumulação de reservas internacionais observada em diversos países está relacionada à vontade de se assegurar contra eventuais crises. Os modelos quantitativos de seguro, entretanto, possuem dificuldade para racionalizar as posições de reserva, a menos que os agentes exibam níveis relativamente altos de aversão ao risco. Esse resultado sugere uma conexão entre o puzzle de reservas internacionais e o equity premium puzzle, que exploramos nesta dissertação. Introduzimos preferências Epstein- Zin em um modelo padrão de default soberano com dívida de longo prazo e um ativo livre de risco, e o calibramos para a economia mexicana. Em seguida, precificamos um ativo de ação dentro do modelo e usamos simulações para estabelecer uma relação positiva entre o nível ótimo de reservas e o equity premium, conforme variamos o grau de aversão ao risco dos agentes domésticos. Usando uma estimativa do equity premium para o México, calibramos o nível de aversão ao risco e encontramos um nível ótimo de reservas internacionais próximo aos dados. Por fim, fornecemos evidência empírica consistente com a relação estabelecida no modelo. Especificamente, introduzimos estimativas do equity premium e, usando especificações crosssectional e de painel, documentamos uma associação positiva e robusta entre essas duas variáveis. / [en] Insurance is a possible explanation for the large holdings of international reserves observed in many countries. Quantitative models of the insurance motive, however, struggle to rationalize reserve positions, unless agents exhibit relatively high levels of risk aversion. This result suggests a connection between the international reserves puzzle and the equity premium puzzle, which we explore in this paper. We introduce Epstein-Zin preferences into a standard sovereign default model with long-term debt and a risk-free asset, and calibrate it to the Mexican economy. We then price an equity claim within the model, and use simulations to establish a positive relationship between optimal reserve holdings and the equity premium, as we vary the degree of risk aversion of domestic agents. Using an estimate of the equity premium for Mexico, we calibrate the level of risk aversion and find it produces an optimal level of international reserves that is close to the data. Finally, we provide empirical evidence consistent with the relationship established with the model. Specifically, we introduce estimates of the equity premium into standard regressions used to explain countries holdings of international reserves. Using both cross-sectional and panel specifications, we document a robust positive association between these two variables.

This thesis contributes to the literature on the consumption-portfolio choice under uncertainty and is motivated by several empirical failures of the standard consumption-based capital asset pricing model (CCAPM). This canonical model has proven disappointing empirically and has even been questioned whether it is theoretically valuable and practically useful even if it is in some sense the only model we have. The frustration is due to that the model performs no better in practice and generates some well-known consumption puzzles and asset pricing puzzles. The purpose of the thesis is to reexamine these puzzles and then to resolve them. After the debate of Hansen and Singleton (1983) and Hall (1988), the estimates of the elasticity of intertemporal substitution (EIS) of consumption in a representative agent model have not resulted in any consensus. Based on this observation, the first chapter of this thesis is focused on resolving the elasticity puzzle or the unresponsiveness to interest rates. We propose a new theoretical and empirical perspective on the relationship between consumption growth and asset returns. In the spirit of Hansen and Singleton (1983), we demonstrate that observed growth rate of consumption responds not only to a specific asset return but also to other asset returns. Empirically, US postwar quarterly data are used to fit the regression model derived in the chapter, and the sample period is 1953Q2-2001Q2. Empirical results show that the EIS is greater than 0.1, the maximum value considered possible by Hall (1988). Accordingly, we argue that there is no elasticity puzzle in the standard representative agent model. The second chapter provides an explanation for the puzzle of excess sensitivity of consumption to expected income proposed by Flavin (1981). We exploit consumer's superior information (i.e., windfalls in investments and in income) to integrate the consumption Euler equations into a generalized Euler equation. The implications emerging from the equation can refute much of the empirical evidence against the permanent income hypothesis (PIH). In short, we conclude that consumption growth is sensitive to windfalls in income, but not to expected income. Thus, Friedman's prescient insight is being formally corroborated in standard utility theory. The equation also provides an alternative approach permitting one more precisely to estimate the preference parameters and much easier to identify the time-series properties of labor income. Empirical results based on U.S. postwar quarterly data show that the EIS is significantly positive and the labor income should follow a nonstationary second-order autoregressive process. The last chapter of the thesis, chapter three, attempts to address the equity premium puzzle, proposed by Mehra and Prescott (1985), and the risk-free rate puzzle, proposed by Weil (1989). These two asset pricing puzzles have troubled financial economists for nearly two decades. To date, there is still no convincing solution for the equity premium puzzle. The CCAPM is apparently inconsistent with the data, especially the annual data in the 1889-1978 period used by Mehra and Prescott (1985). This has led many economists to question whether the model should be abandoned. The purpose of the chapter is to resolve the two puzzles, and then to consolidate the Lucas-Breeden paradigm embedded in the standard CCAPM. We demonstrate that the equity premium puzzle is resulted from the gaps between the expected asset returns and the actual ones. These gaps have conventionally been regarded as regression disturbances, and explained as good luck or unexpected windfalls. We introduce an alternative way that, using other good luck to explain a given good luck, can help fill in the specific gap. Results of numerical calculations and parametric estimation show that, the gap has been significantly narrowed down and hence the equity premium and risk-free rate puzzles are successfully resolved.

This article investigates the impacts of asymmetric information within a Lucas (1978) asset pricing economy. Asymmetry enters via the assumption that one group of agents is equipped with superior information about the dividend process. The agents maximize their lifetime utility of the underlying consumption process obtained from the agents' budget constraints, where the agents have the opportunity to invest in a risk asset to transfer income from the current to future periods. Since a closed form solution for the market price cannot be derived analytically, projection methods are applied, as described in Judd (1998), to approximate the expectation integrals in the agents' Euler equation. We derive the result that the informed trader only clearly improves his situation as compared to the non-trade situation if the uninformed trader only observes his own endowment but not the endowment of the informed trader. In the case where agents observe each others' endowment trade never results in a Pareto improvement. (auhtor's abstract) / Series: Working Papers SFB "Adaptive Information Systems and Modelling in Economics and Management Science"

Understanding the Equity Risk Premium (ERP) and the factors affecting it is cardinal to financial economics, particularly to equity research analysts, domestic and international institutional investors and financial economist. Since the seminal work of Mehra and Prescott (1985) there has been an exponential rise in the research explaining the reasons for ERP puzzle. This review, systematically, investigates the literature related to ERP in four key dimensions. The first dimension is regarding the issues related to different techniques of estimating the ERP. The second dimension is regarding the studies that explain the reasons of existence of the ERP puzzle by making modifications to the preference structures. The third is regarding the macroeconomic variables that help in predicting ERP and the fourth deals with studies that are conducted in the international context. In addition to this, this review meticulously captures some important limitations of the existing literature regarding the estimation of ERP and identifies the domestic and international determinants of ERP, in particular the UK ERP and proposes novel future directions of research. These future research directions have two important implications for my PhD. The first is the academic contribution that predominantly comes from methodological contribution of estimating the ERP. The second is the practical contribution that comes mainly from identifying the unique set of variables (UK domestic and international), which are of prime importance to the domestic and foreign institutional investors because of the financial crisis of 2008-2009 and which should affect the UK ERP.

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