Matt Wilson (University of Oregon) presented new work from the third chapter of his dissertation. The equity premium puzzle is well known to students of modern macro economics. If households value financial instruments based on their future expected discounted present value, as mainstream finance and economics asserts, then the spread between risky and risk free assets should reflect only the increased risk. The premium implied by standard calibrations of DSGE models is much too low. Much analysis has focused on our assumption for the particular value of the CRRA parameter. Economists often assume this to be around 1. To generate premiums commensurate with real world date, this parameter must be significantly higher.

Wilson shows that by considering disaggregated household data on consumption, he can generate empirically realistic equity premia with a CRRA in the range of 2-2.5. Consumption of individual households is much more volatile than aggregate measures, and this volatility allows confidence intervals for parameter estimates that can more closely accommodate standard calibrations.

Slides from the presentation are here.