Financial Jargon Buster Dictionary
This glossary is provided for information only and is not regulated by the Financial Services Authority.
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Equity Risk Premium
The difference between the rate of return available from risk-free assets (such as government bonds) and that available from assuming the risk inherent in more volatile investment such as shares.
The equity premium puzzle is a term coined by economists Rajnish Mehra and Edward C. Prescott. It is based on the observation that in order to reconcile the much higher return on equity stock compared to government bonds in the United States, individuals must have implausibly high risk aversion according to standard economics models. Similar situations prevail in many other industrialized countries. The puzzle has led to an extensive research effort in both macroeconomics and finance. So far a range of useful theoretical tools and several plausible explanations have been presented, but a solution generally accepted by the economics profession remains elusive.
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