Question

Which of the following is a (are) result(s) of the Fama and French (2002) study of the equity premium puzzle? I) Average realized returns during 1950-1999 exceeded the internal rate of return (IRR) for corporate investments. II) The statistical precision of average historical returns is far higher than the precision of estimates from the dividend-discount model (DDM). III) The reward-to-variability ratio (Sharpe) derived from the DDM is far more stable than that derived from realized returns. IV) There is no difference between DDM estimates and actual returns with regard to IRR, statistical precision, or the Sharpe measure.

Answer 1

I) Average realized returns during 1950-1999 exceeded the internal rate of return (IRR) for corporate investments; and

III) The reward-to-variability ratio (Sharpe) derived from the DDM is far more stable than that derived from realized returns.

Step-by-step explanation:

The Fama and French (2002) study of the equity premium puzzle was conducted by Eugene Fama and Kenneth French, who later developed models to describe stock returns.

They conducted the study by breaking their sample onto sub-periods, and they found out that equity premium was largest during the 1950-1999 sub-period.

Therefore they concluded that the equity premium puzzle has occurred mostly in modern times, which was likely due to be due to the difference between the dividend-discount model's (DDM) result of expected return in comparison to realised returns earned. The DDM yields a smaller risk premium during the 1950-1999 period, while realised returns have been higher.

The study also predicts that future excess returns will be significantly lower than those experienced in recent decades.