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Searching for the equity premium

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  • Bai, Hang
  • Zhang, Lu

Abstract

A dynamic stochastic general equilibrium model with recursive utility, search frictions, and capital accumulation is a good start to forming a unified theory of asset prices and business cycles. The model reproduces an equity premium of 4.27% per annum, a stock market volatility of 12.42%, and an average interest rate of 1.97%, while retaining plausible business cycle dynamics. The equity premium and stock market volatility are strongly countercyclical, whereas the interest rate and consumption growth are largely unpredictable. Because of wage inertia, dividends are procyclical despite consumption smoothing via investment. The welfare cost of business cycles is huge, 33.6%.

Suggested Citation

  • Bai, Hang & Zhang, Lu, 2022. "Searching for the equity premium," Journal of Financial Economics, Elsevier, vol. 143(2), pages 897-926.
    • Handle: RePEc:eee:jfinec:v:143:y:2022:i:2:p:897-926
    DOI: 10.1016/j.jfineco.2021.05.024
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    More about this item

    Keywords

    The equity premium puzzle; Macro finance; DSGE; Search frictions; Wage inertia;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • J23 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Labor Demand
    • J64 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Unemployment: Models, Duration, Incidence, and Job Search

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