The Equity Premium Puzzle, Ambiguity Aversion, and Institutional Quality
IMF Working Papers, September 1, 2007
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- The Equity Premium Puzzle, Ambiguity Aversion, and Institutional Quality
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Bibliographic details
- Authors: Abbas Mirakhor, S. Nuri Erbas
- Published: September 1, 2007
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451867947.001
Key findings and conclusions
- Using cross-section data from 53 emerging and mature markets, the study provides evidence that the equity premium puzzle is a global phenomenon.
- Equity premium may reflect not only risk aversion but also ambiguity aversion.
- Some World Bank institutional quality indexes and other proxies for the degree of ambiguity in the sample countries are statistically significant.
- The statistical significance of these indexes indicates that a large part of the equity premium may reflect investor aversion to ambiguities resulting from institutional weaknesses.
Data, scope, and methodology (as described)
- Cross-section sample: 53 emerging and mature markets.
- Independent variables examined: pertinent fundamental variables and World Bank institutional quality indexes, plus other proxies for degree of ambiguity.
- Empirical focus: sources of equity premium, distinguishing contributions from risk aversion and ambiguity aversion.
Implications and interpretation
- The global presence of the equity premium puzzle suggests that explanations limited to single-country or advanced-market settings may be incomplete.
- Institutional quality and ambiguity linked to institutional weaknesses appear to be meaningful determinants of equity return differentials across countries.
- Investor aversion to ambiguity associated with institutional weaknesses is plausibly a major component of observed equity premia.