Unlocking the Equity Premium Puzzle: How Risk and Loss Aversion Shape Markets
The equity premium puzzle questions why investors demand higher returns for stocks than safer investments. The Risk Premium Valuation Model suggests this premium is linked to risk-free rates. Since 1960, the equity risk premium has been around 2 times the risk-free rate. This relationship aligns with the idea of loss aversion from Prospect Theory, offering a potential solution to the puzzle.