TL;DR
This paper proposes a new model that addresses the equity premium puzzle by introducing a sufficiency factor, challenging traditional risk aversion measures, and aligning with empirical data.
Contribution
It develops a novel model with a sufficiency factor that offers a solution to the equity premium puzzle, questioning existing risk aversion measures.
Findings
Coefficient of relative risk aversion is approximately 1.03
Model aligns with empirical risk aversion data
Provides a theoretical solution to the equity premium puzzle
Abstract
This study provides a solution of the equity premium puzzle. Questioning the validity of the Arrow-Pratt measure of relative risk aversion for detecting the risk behavior of investors under all conditions, a new tool, that is, the sufficiency factor of the model was developed to analyze the risk behavior of investors. The calculations of this newly tested model show that the value of the coefficient of relative risk aversion is 1.033526 by assuming the value of the subjective time discount factor as 0.99. Since these values are compatible with the existing empirical studies, they confirm the validity of the newly derived model that provides a solution to the equity premium puzzle.
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