Solution to the Equity Premium Puzzle with Time-Varying Variables

The article's aim is to provide a solution to the Equity Premium Puzzle with a derived model. The derived model which depends on Consumption Capital Asset Pricing Model gives a solution to the puzzle with the values of coefficient of relative risk aversion around 4.40 by assuming the subjective time discount factors as 0.97, 0.98 and 0.99. These values are found compatible with empirical literature. Moreover, the risk-free asset and equity investors are determined as insufficient risk-loving investors in 1977, which can be considered a type of risk-averse behavior. The risk attitude determination also confirms the validity of the model. Hence, it can be stated that calculated values and risk behavior determination demonstrate the correctness of the derived model because test results are robust.