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The Equity Premium: Consistent with GDP Growth and Portfolio Insurance

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  • Christophe Faugère
  • Julian Van Erlach

Abstract

We find that the long-term equity premium is consistent with both GDP growth and portfolio insurance. We use a supply-side growth model and demonstrate that the arithmetic average stock market return and the returns on corporate assets and debt depend on GDP per capita growth. The implied equity premium matches the U.S. historical average over 1926-2001. Separately, we find that the equity premium tracks the value of a put option on the S&P 500. Our theory predicts a smaller equity premium in the future, assuming that the recent regime shifts in dividend policies, interest rates, and tax rates are permanent. Copyright 2006, The Eastern Finance Association.

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Bibliographic Info

Article provided by Eastern Finance Association in its journal Financial Review.

Volume (Year): 41 (2006)
Issue (Month): 4 (November)
Pages: 547-564

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Handle: RePEc:bla:finrev:v:41:y:2006:i:4:p:547-564

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Web page: http://www.easternfinance.org/
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Cited by:
  1. Christophe, Faugere, 2003. "A Required Yield Theory of Stock Market Valuation and Treasury Yield Determination," MPRA Paper 15579, University Library of Munich, Germany, revised 04 Jun 2009.
  2. Blake, David & Cairns, Andrew & Dowd, Kevin, 2008. "Turning pension plans into pension planes: What investment strategy designers of defined contribution pension plans can learn from commercial aircraft designers," MPRA Paper 33749, University Library of Munich, Germany.
  3. Gregorio Impavido & Esperanza Lasagabaster & Manuel Garcia-Huitron, 2010. "New Policies for Mandatory Defined Contribution Pensions : Industrial Organization Models and Investment Products," World Bank Publications, The World Bank, number 2462, July.
  4. Christophe Faugere & Julian Van Erlach, 2004. "A General Theory of Stock Market Valuation and Return," Finance 0403004, EconWPA, revised 17 May 2004.
  5. Cohen, Ruben D, 2009. "Constructing a GDP-based Index for Use as Benchmark," MPRA Paper 18390, University Library of Munich, Germany.

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