The effect of Optimism on teh Equity Premium

Abstract

The Equity Premium Puzzle highlights the occurrence of historical equity premium being an order of magnitude greater than can be rationalized in the context of the standard paradigm of financial economics. Studies have shown that pessimism may explain this puzzle.

The purpose of this thesis is to examine the effect of optimism on the equity premium. By using data of optimism and equity premia from different countries the study shows a possible relationship between the two variables. This relationship is shown to be an inverse one, i.e. the equity risk premium decreases as optimism increases. However, the findings can be considered unreliable due to contradictions in the results when testing different datasets. Ultimately, there are possible ways to improve the datasets and develop the model to obtain credible results.