A Note on the Interrelation of Volatility Puzzle, Equity Premium Puzzle, and Mean Reversion through State Dependent Preferences
- *Corresponding Author:
- Christos I Giannikos
Department of Economics and Finance
Zicklin School of Business
Baruch College/CUNY, One Baruch Way
Box B10-225, New York, USA
E-mail: [email protected]
Received June 26, 2013; Accepted September 17, 2013; Published Sptember 20, 2013
Citation: Sung-Sup C, Giannikos IC (2013) A Note on the Interrelation of Volatility Puzzle, Equity Premium Puzzle, and Mean Reversion through State Dependent Preferences. J Bus Fin Aff 2:112. doi:10.4172/2167-0234.1000112
Copyright: © 2013 Sung-Sup C, et al. This is an open-access article distributed under the terms of the Creative Commons Attribution License, which permits unrestricted use, distribution, and reproduction in any medium, provided the original author and source are credited.
According to empirical studies, there is a systematic pattern in the temporal behavior of asset returns and this is related to the business cycle. We propose a simple model that captures this behavior. This model is built around a state dependent preference structure where the state dependency is related to the business cycle. In this setting the volatility puzzle, the equity premium puzzle and mean-reversion appear to be indeed interrelated phenomena. A necessary condition for the three puzzles to be explained is that the state variable is negatively correlated with the market portfolio cum business cycle.