Working Paper: CEPR ID: DP1119
Authors: Fabio Canova; Gianni De Nicolo
Abstract: This paper examines the relationship between the equity premium and the risk free rate at three different maturities using post-1973 data for a panel of seven OECD countries. We show the existence of subsample instabilities, of some cross country differences and of inconsistencies with the expectations theory of the term structure. We perform simulations using a standard consumption based CAPM model and demonstrate that the basic features of Mehra and Prescott's (1985) puzzle remain, regardless of the time period, the investment maturity and the country considered. Modifications of the basic set-up are also considered.
Keywords: equity premium; risk free rate; term structure; consumption based CAPM; calibration; model evaluation
JEL Codes: C15; E43; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| equity premium (G12) | risk-free rate (G12) |
| risk-free rate properties (G12) | equity premium (G12) |
| expectations theory violations (D84) | equity premium (G12) |
| Arrow-Debreu model (G19) | equity premium (G12) |
| heterogeneity in deep parameters (C45) | time variations in equity premium (G12) |
| risk-free rate properties (G12) | risk-free rate (G12) |