Behavioral Economics and the Equity Premium Puzzle. Which Solutions Do Rational Economist Suggest?

Seminar paper from the year 2018 in the subject Business economics - Investment and Finance, grade: 1.7, University of Hamburg, language: English, abstract: The work investigates the Equity Premium Puzzle as described by Siegel and Thaler in 1997. Investigations in the thesis are centered around the question of how behavioral economics can explain the anomalies of stock markets and the equity premium. As the research question implies, this work will examine solutions of the puzzle suggested from both the field of rational economics and behavioral economics. Due to a large number of various approaches to explain the puzzle over the past 30 years, this work will concentrate on a selected number of suggestions from various economists. I will examine assumptions and conditions of the solutions suggested, and analyze key theories applied in the resolutions. The quantitative foundation of models analyzed in this work will not be examined, as this would require detailed statistical and mathematical considerations. The work is structured as follows. I will to begin with outline the initial puzzle stated by Mehra and Prescott in 1985 and analyze key assumptions of their equilibrium model. Different resolutions of the puzzle suggested by rational and behavioral economics will then be examined, followed by an investigation of the empirical evidence behind the proposed solutions. A discussion will follow, and the author will reflect on the robustness and relevance of the puzzle. A conclusion will sum up the key elements of the work.