The Equity Risk Premium Puzzle in Pakistan

Our study uses the consumption-based asset-pricing power utility model to test theEquity Risk Premium (ERP) puzzle in Pakistan. The study has collected monthly stock pricedata from July 1997 to December 2017 from the PSX data portal. We extracted informationabout macroeconomic factors such as inflation and risk-free interest rate from the State Bankof Pakistan. Moreover, the study used private consumption and population data from thePakistan Bureau of Statistics. The results suggest that the ERP puzzle has a strong occurrencein Pakistan, a phenomenon previously associated with only developed markets. Onedisadvantage of the present investigation is the small sample size. A longer time durationcould have reduced short-term biases. Past researchers have suggested different approachesfor solving the equity premium puzzle. For instance, some studies used improvised structuralmodels to justify the equity risk premium puzzle using macroeconomic factors.