Exact Solutions for Expected Rates of Return Under Markov Regime Switching: Implications for the Equity Premium Puzzle
Year: 1992
Type: report
Abstract: This paper derives simple closed-form solutions for expected rates of return on stocks and riskless one-period bills under the assumption that shocks to the growth rates of consumption and dividends are generated by a Markov regime-switching process. These closed-form solutions are used to show that the Markov regime-switching process exacerbates the equity premium puzzle and the risk-free rate puzzle. Three empirical examples illustrate the magnitude of the effects of Markov regime switching on equilibrium expected returns.
DOI: 10.3386/w4110
Author: Andrew Abel
Language: English
Subfield: Finance
Domain: Social Sciences
Open Access status: green
OpenAlex ID: W3121828613