Examining the Equity Premium Puzzle in Iran: A Practical Approach Using a Dynamic Stochastic General Equilibrium Model

The equity premium is obtained from the difference between the return on the risky stock asset and the return on the risk-free asset; the failure of financial theory to explain high equity premium is known as the equity premium puzzle. This puzzle was introduced for the first time by Mehra and Prescott in the framework of the C-CAPM model and states that stock returns are so high that it cannot be explained by the fluctuation of real consumption growth. Therefore, the examination of the puzzle is important because it provides the basis for the correction of models that lead to failure when faced with financial data. The purpose of the present study is to investigate the equity premium puzzle in Iran. Focusing on the relationship between the real and financial sectors, this study has specified a DSGE model in accordance with the conditions of Iran's economy. The specified model can investigate the equity premium puzzle in Iran by applying technology shocks, government spending, oil revenue, stock price index shock and money supply and the effect of these shocks on asset returns and consumption. The results show that the productivity shock, oil income shock and stock price shock in the high-risk aversion parameter while smoothing the consumption and creating a high equity premium can explain the equity premium puzzle in Iran.