THE EQUITY PREMIUM AND RISK-FREE RATE PUZZLES IN A TURBULENT ECONOMY: EVIDENCE FROM 105 YEARS OF DATA FROM SOUTH AFRICA

This paper presents a detailed empirical examination of the South African equity premium, and a quantitative theoretic exercise to test the canonical inter-temporal consumption-based asset-pricing model under power utility. Over the long run, the South African stock market produced average returns six to eight percentage points above bonds and cash, and at the 20-year horizon, an investor would not have experienced a single negative realised equity premium over the entire 105-year period we examine. Yet the maximum equity premium rationalised by the consumption-based model is 0.4%. The canonical macro-financial model closely matches the average risk-free rate, using realistic parameters for the coefficient of risk aversion and a positive rate of time preference.