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Investments glossary

Equity Premium Puzzle (EPP)


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— Mother Teresa

The equity premium puzzle (EPP) is a phenomenon that describes the anomalously higher historical real returns of stocks over government bonds. The equity premium, which is defined as equity returns minus bond returns, has been approximately 6.4% on average over a 100+ year period in the U.S. The premium is supposed to reflect the relative risk of stocks compared to risk-free government bonds, but the puzzle arises because this unexpectedly large percentage implies an unreasonably high level of risk aversion among investors.


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