alexa A Note on the Interrelation of Volatility Puzzle, Equity Premium Puzzle,and Mean Reversion through State Dependent Preferences
ISSN: 2167-0234

Journal of Business & Financial Affairs
Open Access

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Research Article

A Note on the Interrelation of Volatility Puzzle, Equity Premium Puzzle,and Mean Reversion through State Dependent Preferences

Sung-Sup C1 and Giannikos IC2

1Graduate School of Busin`ess Administration, Gachon University, Seongnam-daero, Korea

2Department of Economics and Finance, Zicklin School of Business, Baruch College, City University of New York ,USA

*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.

 

Abstract

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.

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