Advanced Search
MyIDEAS: Login to save this paper or follow this series

Corporate Earnings and the Equity Premium

Contents:

Author Info

  • Longstaff, Francis
  • Piazzesi, Monika
Registered author(s):

    Abstract

    Economic shocks affect corporate cash flows far more than they do aggregate consumption. We examine the asset-pricing implications of corporate sensitivity to shocks using a continuous-time representative agent framework in which earnings are a stochastic fraction of total consumption. We provide closed-form solutions for equity values when earnings and consumption follow exponential-affine jump-diffusion processes. Calibrating the model to historical data, we show that the extreme sensitivity of corporate cash flows to shocks dramatically increases the equity premium. The model implies realistic values for the equity premium given modest levels of risk aversion and generates levels of equity volatility consistent with those experienced by the stock

    Download Info

    If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
    File URL: http://www.escholarship.org/uc/item/3qn115m4.pdf;origin=repeccitec
    Download Restriction: no

    Bibliographic Info

    Paper provided by Anderson Graduate School of Management, UCLA in its series University of California at Los Angeles, Anderson Graduate School of Management with number qt3qn115m4.

    as in new window
    Length:
    Date of creation: 01 Sep 2002
    Date of revision:
    Handle: RePEc:cdl:anderf:qt3qn115m4

    Contact details of provider:
    Postal: 110 Westwood Plaza, Los Angeles, CA. 90095
    Web page: http://www.escholarship.org/repec/anderson_fin/
    More information through EDIRC

    Related research

    Keywords:

    References

    References listed on IDEAS
    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
    as in new window
    1. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
    2. Harry Mamaysky, 2002. "A Model For Pricing Stocks and Bonds," Yale School of Management Working Papers ysm279, Yale School of Management, revised 01 Jun 2002.
    3. Lior Menzly & Tano Santos & Pietro Veronesi, 2002. "The Time Series of the Cross Section of Asset Prices," NBER Working Papers 9217, National Bureau of Economic Research, Inc.
    4. Lettau, Martin & Ludvigson, Sydney C., 2005. "Expected returns and expected dividend growth," Journal of Financial Economics, Elsevier, vol. 76(3), pages 583-626, June.
    5. Harry Mamaysky, 2002. "A Model for Pricing Stocks and Bonds with Default Risk," Yale School of Management Working Papers ysm286, Yale School of Management.
    6. Bakshi, Gurdip S. & Zhiwu, Chen, 1997. "An alternative valuation model for contingent claims," Journal of Financial Economics, Elsevier, vol. 44(1), pages 123-165, April.
    7. Sundaresan, Suresh M, 1989. "Intertemporally Dependent Preferences and the Volatility of Consumption and Wealth," Review of Financial Studies, Society for Financial Studies, vol. 2(1), pages 73-89.
    8. John Y. Campbell & John H. Cochrane, 1994. "By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," CRSP working papers 412, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
    9. R. C. Merton, 1970. "Optimum Consumption and Portfolio Rules in a Continuous-time Model," Working papers 58, Massachusetts Institute of Technology (MIT), Department of Economics.
    10. J. Nellie Liang & Steven A. Sharpe, 1999. "Share repurchases and employee stock options and their implications for S&P 500 share retirements and expected returns," Finance and Economics Discussion Series 1999-59, Board of Governors of the Federal Reserve System (U.S.).
    11. Abel, A.B., 1990. "Asset Prices Under Habit Formation And Catching Up With The Joneses," Weiss Center Working Papers 1-90, Wharton School - Weiss Center for International Financial Research.
    12. Nicholas Barberis & Ming Huang, 2001. "Mental Accounting, Loss Aversion, and Individual Stock Returns," NBER Working Papers 8190, National Bureau of Economic Research, Inc.
    13. Detemple, Jerome B & Zapatero, Fernando, 1991. "Asset Prices in an Exchange Economy with Habit Formation," Econometrica, Econometric Society, vol. 59(6), pages 1633-57, November.
    14. Robert E. Hall, 1999. "The Stock Market and Capital Accumulation," NBER Working Papers 7180, National Bureau of Economic Research, Inc.
    15. Lettau, M. & Uhlig, H., 1995. "Can Habit Formation be Reconciled with Business Cycle Facts?," Discussion Paper 1995-54, Tilburg University, Center for Economic Research.
    16. David A. Chapman, 1998. "Habit Formation and Aggregate Consumption," Econometrica, Econometric Society, vol. 66(5), pages 1223-1230, September.
    17. Kocherlakota, N., 1995. "The Equity Premium: It's Still a Puzzle," Working Papers 95-05, University of Iowa, Department of Economics.
    18. Ellen R. McGrattan & Edward C. Prescott, 2001. "Taxes, Regulations, and Asset Prices," NBER Working Papers 8623, National Bureau of Economic Research, Inc.
    19. Zengjing Chen & Larry G. Epstein, 2000. "Ambiguity, risk and asset returns in continuous time," RCER Working Papers 474, University of Rochester - Center for Economic Research (RCER).
    20. Andrew B. Abel, 1998. "Risk Premia and Term Premia in General Equilibrium," NBER Working Papers 6683, National Bureau of Economic Research, Inc.
    21. Naik, Vasanttilak & Lee, Moon, 1990. "General Equilibrium Pricing of Options on the Market Portfolio with Discontinuous Returns," Review of Financial Studies, Society for Financial Studies, vol. 3(4), pages 493-521.
    22. Cecchetti, Stephen G. & Lam, Pok-sang & Mark, Nelson C., 1993. "The equity premium and the risk-free rate : Matching the moments," Journal of Monetary Economics, Elsevier, vol. 31(1), pages 21-45, February.
    23. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
    24. Philippe Weil, 1989. "The Equity Premium Puzzle and the Riskfree Rate Puzzle," NBER Working Papers 2829, National Bureau of Economic Research, Inc.
    25. G. Constantinides, 1990. "Habit formation: a resolution of the equity premium puzzle," Levine's Working Paper Archive 1397, David K. Levine.
    26. Campbell, John, 1986. "Bond and Stock Returns in a Simple Exchange Model," Scholarly Articles 3122544, Harvard University Department of Economics.
    27. Breeden, Douglas T., 1979. "An intertemporal asset pricing model with stochastic consumption and investment opportunities," Journal of Financial Economics, Elsevier, vol. 7(3), pages 265-296, September.
    28. Tano Santos & Pietro Veronesi, 2001. "Labor Income and Predictable Stock Returns," NBER Working Papers 8309, National Bureau of Economic Research, Inc.
    29. John H. Cochrane, 1998. "Where is the Market Going? Uncertain Facts and Novel Theories," NBER Working Papers 6207, National Bureau of Economic Research, Inc.
    30. Lars Peter Hansen & Thomas J. Sargent & Thomas D. Tallarini Jr., 1997. "Robust Permanent Income and Pricing," Levine's Working Paper Archive 596, David K. Levine.
    31. Philippe Jorion & William N. Goetzmann, 1999. "Global Stock Markets in the Twentieth Century," Journal of Finance, American Finance Association, vol. 54(3), pages 953-980, 06.
    32. Ivo Welch, 2001. "The Equity Premium Consensus Forecast Revisited," Cowles Foundation Discussion Papers 1325, Cowles Foundation for Research in Economics, Yale University.
    33. Brennan, Michael J. & Xia, Yihong, 2001. "Stock price volatility and equity premium," Journal of Monetary Economics, Elsevier, vol. 47(2), pages 249-283, April.
    Full references (including those not matched with items on IDEAS)

    Citations

    Lists

    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

    Statistics

    Access and download statistics

    Corrections

    When requesting a correction, please mention this item's handle: RePEc:cdl:anderf:qt3qn115m4. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Lisa Schiff).

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.