The Total Risk Premium Puzzle

The risk premium puzzle is worse than you think. Using a new database for the U.S. and 15 other advancedeconomies from 1870 to the present that includes housing as well as equity returns (to capture thefull risky capital portfolio of the representative agent), standard calculations using returns to total wealthand consumption show that: housing returns in the long run are comparable to those of equities, andyet housing returns have lower volatility and lower covariance with consumption growth than equities.The same applies to a weighted total-wealth portfolio, and over a range of horizons. As a result, theimplied risk aversion parameters for housing wealth and total wealth are even larger than those forequities, often by a factor of 2 or more. We find that more exotic models cannot resolve these evenbigger puzzles, and we see little role for limited participation, idiosyncratic housing risk, transactioncosts, or liquidity premiums.

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