Equity Premium Puzzle - EPP

What Does Equity Premium Puzzle - EPP Mean?
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.

Filed Under: Acronyms, Bonds, Statistics

Related Terms

Capital Asset Pricing Model - CAPM
Consumption Capital Asset Pricing Model - CCAPM
Equity Risk Premium
Expected Return
Gambler's Fallacy
Real Rate Of Return
Risk Averse
Risk-Free Rate Of Return
Risk-Free Rate Puzzle - RFRP
Risk-Return Tradeoff
More Related Terms

Related Links

Catch On To The CCAPM - This model smooths over some of CAPM's weaknesses to make sense of risk aversion.
Behavioral Finance - Learn the science behind irrational decision making and how you can avoid it.
Equity Premiums: Looking Back And Looking Ahead - If stocks become less profitable in the future, you may have to change your investment strategy.
The Bond Market: A Look Back - Find out how fixed-income investments evolved in the past century and what it means today.
An Overview Of The Equity Risk Premium - Learn how the expected extra return on stocks is measured and why academic studies usually estimate a low premium.
The Capital Asset Pricing Model: An Overview - CAPM helps you determine what return you deserve for putting your money at risk.
Behavioral Finance: Anomalies - The presence of regularly occurring anomalies in conventional economic theory was a big contributor to the formation of behavioral finance.

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