Equity Premium Puzzle - EPP

AAA

DEFINITION of 'Equity Premium Puzzle - EPP'

An phenomenon that describes the anomalously higher historical real returns of stocks over government bonds. The equity premium, which is defined as equity returns less bond returns, has been about 6% on average for the past century. It is supposed to reflect the relative risk of stocks compared to "risk-free" government bonds, but the puzzle arises because this unexpectedly large percentage implies a suspiciously high level of risk aversion among investors.

INVESTOPEDIA EXPLAINS 'Equity Premium Puzzle - EPP'

The equity premium puzzle is a mystery to financial academics. According to some academics, the difference is too large to reflect a "proper" level of compensation that would occur as a result of investor risk aversion; therefore, the premium should actually be much lower than the historic average of 6%.

More recent extensions to the puzzle attempt to offer a different rationale for explaining the EPP, such as investor prospects and macroeconomic influences. No matter the explanation, the fact remains that investors are being rewarded very well for holding equity compared to government bonds.

RELATED TERMS
  1. Equivalent Martingale Measures

    In asset pricing, a probability distribution of expected payouts ...
  2. Capital Asset Pricing Model - CAPM

    A model that describes the relationship between risk and expected ...
  3. Equity Risk Premium

    The excess return that an individual stock or the overall stock ...
  4. Expected Return

    The amount one would anticipate receiving on an investment that ...
  5. Real Rate Of Return

    The annual percentage return realized on an investment, which ...
  6. Risk-Free Rate Of Return

    The theoretical rate of return of an investment with zero risk. ...
Related Articles
  1. The Bond Market: A Look Back
    Mutual Funds & ETFs

    The Bond Market: A Look Back

  2. The Capital Asset Pricing Model: An ...
    Fundamental Analysis

    The Capital Asset Pricing Model: An ...

  3. Catch On To The CCAPM
    Fundamental Analysis

    Catch On To The CCAPM

  4. The Equity-Risk Premium: More Risk For ...
    Fundamental Analysis

    The Equity-Risk Premium: More Risk For ...

comments powered by Disqus
Hot Definitions
  1. Odious Debt

    Money borrowed by one country from another country and then misappropriated by national rulers. A nation's debt becomes odious ...
  2. Takeover

    A corporate action where an acquiring company makes a bid for an acquiree. If the target company is publicly traded, the ...
  3. Harvest Strategy

    A strategy in which investment in a particular line of business is reduced or eliminated because the revenue brought in by ...
  4. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  5. Pareto Principle

    A principle, named after economist Vilfredo Pareto, that specifies an unequal relationship between inputs and outputs. The ...
  6. Pareto Principle

    A principle, named after economist Vilfredo Pareto, that specifies an unequal relationship between inputs and outputs. The ...
Trading Center