The Loss Aversion/Narrow Framing Approach to the Equity Premium Puzzle

36 Pages Posted: 10 Jul 2006

See all articles by Nicholas Barberis

Nicholas Barberis

Yale School of Management; National Bureau of Economic Research (NBER)

Ming Huang

Cornell University - Samuel Curtis Johnson Graduate School of Management

Multiple version iconThere are 2 versions of this paper

Date Written: April 2006

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.

Keywords: loss aversion, narrow framing, equity premium

JEL Classification: G11, G12

Suggested Citation

Barberis, Nicholas and Huang, Ming, The Loss Aversion/Narrow Framing Approach to the Equity Premium Puzzle (April 2006). Available at SSRN: https://ssrn.com/abstract=912776 or http://dx.doi.org/10.2139/ssrn.912776

Nicholas Barberis (Contact Author)

Yale School of Management ( email )

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National Bureau of Economic Research (NBER)

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Ming Huang

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Ithaca, NY 14853
United States
607-225-9594 (Phone)

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