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The Loss Aversion / Narrow Framing Approach to the Equity Premium Puzzle / Nicholas Barberis, Ming Huang.

By: Contributor(s): Material type: TextTextSeries: Working Paper Series (National Bureau of Economic Research) ; no. w12378.Publication details: Cambridge, Mass. National Bureau of Economic Research 2006.Description: 1 online resource: illustrations (black and white)Subject(s): Online resources: Available additional physical forms:
  • Hardcopy version available to institutional subscribers
Abstract: We review a recent approach to understanding the equity premium puzzle. The key elements of this approach are loss aversion and narrow framing, two well-known features of decision-making under risk in experimental settings. In equilibrium, models that incorporate these ideas can generate a large equity premium and a low and stable risk-free rate, even when consumption growth is smooth and only weakly correlated with the stock market. Moreover, they can do so for parameter values that correspond to sensible attitudes to independent monetary gambles. We conclude by suggesting some possible directions for future research.
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July 2006.

We review a recent approach to understanding the equity premium puzzle. The key elements of this approach are loss aversion and narrow framing, two well-known features of decision-making under risk in experimental settings. In equilibrium, models that incorporate these ideas can generate a large equity premium and a low and stable risk-free rate, even when consumption growth is smooth and only weakly correlated with the stock market. Moreover, they can do so for parameter values that correspond to sensible attitudes to independent monetary gambles. We conclude by suggesting some possible directions for future research.

Hardcopy version available to institutional subscribers

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