Working Paper Series, Department of Economics, Uppsala University
No 2005:11:
Myopic Loss Aversion, the Equity Premium Puzzle, and GARCH
Martin Ågren
Abstract: This paper concerns the distributional assumptions made on
stock returns in the myopic loss aversion (MLA) proposed explanation to the
equity premium puzzle. While Benartzi and Thaler (1995) assume temporal
independence in these returns, we introduce a more realistic assumption
incorporating conditional heteroskedasticity. This involves the work on
temporal aggregation of GARCH processes of Drost and Nijman (1993). Using
Swedish data, our estimation method produces an overall larger evaluation
period than the one originally obtained by Benartzi and Thaler, e.g., over
the sample period July 1961 through December 2003 the evaluation period
increases from 12 to 17. This shows that MLA indeed can explain a large
equity premium but, also, that the model is sensitive to the distributional
assumption made on stock returns.
Keywords: Prospect theory; loss aversion; equity premium; GARCH; (follow links to similar papers)
JEL-Codes: C22; G11; (follow links to similar papers)
34 pages, January 21, 2005
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