The Equity Premium Puzzle and the Ex Post Bias

This paper argues that the high historical excess returns to equity are1 a result of a severe ex post bias over the period from 1915 to circa 1960 because inflation surprises during this period drove a wedge between ex ante and ex post returns to bonds. Furthermore, it is shown that ex ante and ex post returns to shares are identical in steady state. Adjusting the ex post equity premium by the ex post bias reduces the equity premium to an arithmetic mean of 3.5-3.9% over the past 130 years.