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A Comment on 'The Equity Premium. A Puzzle'


The results in this paper by Mehra and Prescott conflict with other evidence on the equity premium. The reason is that they substitute the smooth per capita consumption on nondurables and services for the more variable true payment process when calculating the price of the market index. In fact, their theoretical equity premium constitutes a lower boundary for the actual premium. The data are shown to be consistent with the corresponding upper boundary also. Hence they do not reject the Arrow-Debreu equilibrium model.

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