Abstract:
This paper investigates the equity risk premium puzzle in the Indonesian and Sri Lankan
stock markets in order to identify the relationship between the volatility of excess
returns and the equity risk premium. The asymmetric impact of negative shocks on
the equity risk premium is also examined using threshold and exponential GARCH-M
models. We analyse data on the excess returns of the Indonesian and Sri Lankan stock
markets from 2004 to 2013, and we find that the impact of the conditional volatility of
excess returns on the equity risk premium is not significant in either country. Instead,
we find an impact from negative return shocks on the equity risk premium only in Sri
Lanka. Therefore, we conclude that investors are not compensated for the conditional
volatility of the excess returns in these two markets, while Sri Lankan investors are
compensated for the risk of negative shocks.
