The equity premium and risk-free rate puzzles in a turbulent economy:  Evidence from 105 years of data from South Africa

Hassan, Shakill; van Biljon, Andrew

The equity premium and risk-free rate puzzles in a turbulent economy: Evidence from 105 years of data from South Africa

Journal Article

2010

Journal Title

South African Journal of Economics

Link to Journal

http://onlinelibrary.wiley.com/doi/10.1111/j.1813-6982.2010.01237.x/abstract

Publisher

University of Cape Town

Department

School of Economics

Faculty

Faculty of Commerce

Abstract

This paper presents a detailed empirical examination of the South African equity premium, and a quantitative theoretic exercise to test the canonical inter-temporal consumption-based assetpricing model under power utility. Over the long run, the South African stock market produced average returns six to eight percentage points above bonds and cash, and at the 20-year horizon, an investor would not have experienced a single negative realised equity premium over the entire 105-year period we examine. Yet the maximum equity premium rationalised by the consumptionbased model is 0.4%. The canonical macro-financial model closely matches the average risk-free rate, using realistic parameters for the coefficient of risk aversion and a positive rate of time preference.

Keywords

Consumption-based asset pricing, stochastic discount factor, equity risk premium puzzle, risk-free rate, risk aversion coefficient, South Africa

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