The Equity Premium Puzzle and Emotional Asset Pricing

Since the equity premium as well as the risk-free rate puzzle question the concepts centralto financial and economic modeling, we apply behavioral decision theory to asset pricing in view ofsolving these puzzles. U.S. stock market data for the period 1960-2003 and German stock marketdata for the period 1977-2003 show that emotional investors who act in accordance to Bell's (1985)disappointment theory − a special case of prospect theory − and additionally administer mental accountsdemand a high equity premium. Furthermore, these investors reason...