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Title: The Total Risk Premium Puzzle

Author(s): Ďscar JordÓ, Moritz Schularick and Alan M. Taylor

Publication Date: March 2019

Keyword(s): Consumption-based asset pricing, Equity premium, housing premium and risk aversion

Programme Area(s): Economic History, Financial Economics, International Macroeconomics and Finance and Macroeconomics and Growth

Abstract: The risk premium puzzle is worse than you think. Using a new database for the U.S. and 15 other advanced economies from 1870 to the present that includes housing as well as equity returns (to capture the full risky capital portfolio of the representative agent), standard calculations using returns to total wealth and consumption show that: housing returns in the long run are comparable to those of equities, and yet housing returns have lower volatility and lower covariance with consumption growth than equities. The same applies to a weighted total-wealth portfolio, and over a range of horizons. As a result, the implied risk aversion parameters for housing wealth and total wealth are even larger than those for equities, often by a factor of 2 or more. We find that more exotic models cannot resolve these even bigger puzzles, and we see little role for limited participation, idiosyncratic housing risk, transaction costs, or liquidity premiums.

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Bibliographic Reference

JordÓ, Ď, Schularick, M and Taylor, A. 2019. 'The Total Risk Premium Puzzle'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=13595