ABSTRACT
Some observers have also interpreted the inability of parameterized versions of standard neoclassical general equilibrium models to account for the historically high average spreads between risky securities and short-term Treasury rates (the ‘equity premium puzzle’) as evidence of capital market imperfections. Taking into account individual risk exposure, however, does not appear to explain that puzzle (e.g., Heaton & Lucas, 1996). In fact, the robust predictions of economic theory put very few quantitative restrictions on price levels or returns. Hence, observed market premiums are difficult to interpret as evidence for or against the efficiency of financial markets in spreading risk.
