Abstract
This study provides the solution to the equity premium puzzle. The new model was developed by including the behavior of investors toward risk in financial markets in prior studies. The calculations of this newly tested model show that the value of the coefficient of relative risk aversion is 1.033526 by assuming the value of the subjective time discount factor to be 0.99. Furthermore, investors investing in risk-free asset allocate negative utility for an uncertain wealth value, while those investing in equity allocate positive utility for an uncertain wealth value in 1977 that is automatically selected as the year for the determination of the behavior of investors toward risk. Since the above mentioned values are compatible with the existing empirical studies, they confirm the validity of the newly derived model that provides the solution to the equity premium puzzle.
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