Is Rationality Bounded？ An Interpretation on Equity Premium Puzzle

Abstract: Since equity premium puzzle had long been a problem, many economists tried to give reasonable interpretations to the puzzle. I focus on the type of theories using bounded rationality as the answer to the problem. I am willing to find out that whether the puzzle still exists in recent decades. If it does exist, are the theories of bounded rationality still able to explain the puzzle? In the beginning, I introduce two theories referring to bounded rationality. Afterwards, I empirically analyze the data of the U.S., Japan and Euro-area by using a simpler model based on rationality. Interestingly, circumstances vary a lot from country to country. One theory may be suitable for one country but not for the others. Even so, the “suitable” theory fails to completely explain the whole tendency of variation during the observed period in the country. In the future, we still need to explore in depth of the puzzle.