Equity Premium Puzzle and Bubble Risk and Epstein- Zin Recursive Preferences Function in Iran’s Securities Market

Abstract

The present study aims to interpret equity premium puzzle based on the bubble risk approach in Iran’s securities market for the period 1996:09-2016:10. To this end, discovery of bubbles, estimation of the Epstein-Zin Preferences function, and interpretation of equity premium are examined. After that, RTADF tests are used to discover bubbles and date their stamping. Research results indicate that the securities market has experienced six bubble periods and has not had bubble in 65 percent of the period. In addition, the Epstein- Zin Preferences function of this study is estimated using GMM method. In this stage, estimation of elasticity of intertemporal substitution parameter is very important since it is expected that the risk of bubble is used to describe a part of stock market’s risk. Results of the study indicate that market bubbles have boosted risk factors in the securities market. In addition, economic factors in the securities market of Iran are substantially risk averse. Findings show that based on the traditional approach, a comprehensive interpretation of equity premium puzzle could not be presented; while the new approach can ascertain 90 percent of equity premium.

Keywords

• asset pricing
• bubbles
• present value model
• epstein- zin preferences function