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Earnings Inequality and the Equity Premium

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  • Walentin Karl

    ()
    (Sveriges Riksbank)

Abstract

In this paper, we document a 75 percent increase in stockholders' share of aggregate labor income in the U.S. from 1962 to 2000 using data from Survey of Consumer Finances. Our decomposition of the increase in stockholders' share of aggregate labor income documents that one half is due to the equi-proportional increase in participation and one quarter each is due to the non-proportional part of the changes in stockmarket participation and changes in the income distribution, respectively. The change due to the labor income distribution is driven entirely by the increase in the share of labor income accounted for by the top labor income decile. Using a simple model with limited stockmarket participation, we present a mechanism for how the increase in stockholders' share of aggregate labor income has affected the ex ante equity premium (i.e. the discount rate applied to equity). The mechanism works through the composition of income of stockholders. The resulting decrease in the equity premium is 44 percent, which roughly coincides with the historical change in the post-1951 equity premium implied by the simple dividend growth model in Fama and French (2002).

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Bibliographic Info

Article provided by De Gruyter in its journal The B.E. Journal of Macroeconomics.

Volume (Year): 10 (2010)
Issue (Month): 1 (November)
Pages: 1-23

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Handle: RePEc:bpj:bejmac:v:10:y:2010:i:1:n:36

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Cited by:
  1. Favilukis, Jack, 2013. "Inequality, stock market participation, and the equity premium," Journal of Financial Economics, Elsevier, vol. 107(3), pages 740-759.
  2. Zervou, Anastasia S., 2013. "Financial market segmentation, stock market volatility and the role of monetary policy," European Economic Review, Elsevier, vol. 63(C), pages 256-272.

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