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Macroeconomic volatility and the equity premium

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  • Keith Sill

Abstract

Recent empirical work documents a decline in the U.S. equity premium and a decline in the standard deviation of real output growth. We investigate the link between aggregate risk and the asset returns in a dynamic production based asset-pricing model. When calibrated to match asset return moments, the model implies that the post-1984 reduction in TFP shock volatility of 60 percent gives rise to a 40 percent decline in the equity premium. Lower macroeconomic risk post-1984 can account for a substantial fraction of the decline in the equity premium.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 06-1.

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Date of creation: 2006
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Handle: RePEc:fip:fedpwp:06-1

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Keywords: Equity ; Macroeconomics;

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References

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  1. Susanto Basu & John Fernald & Miles Kimball, 2004. "Are Technology Improvements Contractionary?," NBER Working Papers 10592, National Bureau of Economic Research, Inc.
  2. Martin Lettau & Sydney C. Ludvigson & Jessica A. Wachter, 2004. "The Declining Equity Premium: What Role Does Macroeconomic Risk Play?," NBER Working Papers 10270, National Bureau of Economic Research, Inc.
  3. Andrew B. Abel, 1998. "Risk Premia and Term Premia in General Equilibrium," NBER Working Papers 6683, National Bureau of Economic Research, Inc.
  4. Ravi Jagannathan & Ellen R. McGrattan & Anna Scherbina., 2000. "The declining U.S. equity premium," Quarterly Review, Federal Reserve Bank of Minneapolis, Federal Reserve Bank of Minneapolis, issue Fall, pages 3-19.
  5. Chang-Jin Kim & Charles Nelson & Jeremy M. Piger, 2003. "The less volatile U.S. economy: a Bayesian investigation of timing, breadth, and potential explanations," Working Papers, Federal Reserve Bank of St. Louis 2001-016, Federal Reserve Bank of St. Louis.
  6. Lee Ohanian & Andres Arias & Gary Hansen, 2005. "Why have business cycle fluctuations become less volatile?," 2005 Meeting Papers, Society for Economic Dynamics 927, Society for Economic Dynamics.
  7. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
  8. Neville Francis & Valerie A. Ramey, 2002. "Is the Technology-Driven Real Business Cycle Hypothesis Dead?," NBER Working Papers 8726, National Bureau of Economic Research, Inc.
  9. Leduc, Sylvain & Sill, Keith, 2004. "A quantitative analysis of oil-price shocks, systematic monetary policy, and economic downturns," Journal of Monetary Economics, Elsevier, Elsevier, vol. 51(4), pages 781-808, May.
  10. John Shea, 1998. "What Do Technology Shocks Do?," NBER Working Papers 6632, National Bureau of Economic Research, Inc.
  11. Michele Boldrin & Lawrence J. Christiano & Jonas D.M. Fisher, 1999. "Habit persistence, asset returns and the business cycles," Working Paper Series, Federal Reserve Bank of Chicago WP-99-14, Federal Reserve Bank of Chicago.
  12. Olivier Blanchard & John Simon, 2001. "The Long and Large Decline in U.S. Output Volatility," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, Economic Studies Program, The Brookings Institution, vol. 32(1), pages 135-174.
  13. Carmen Broto & Esther Ruiz, 2002. "Estimation Methods For Stochastic Volatility Models: A Survey," Statistics and Econometrics Working Papers, Universidad Carlos III, Departamento de Estadística y Econometría ws025414, Universidad Carlos III, Departamento de Estadística y Econometría.
  14. Sylvain Leduc & Keith Sill, 2007. "Monetary Policy, Oil Shocks, and TFP: Accounting for the Decline in U.S. Volatility," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 10(4), pages 595-614, October.
  15. Jermann, Urban J., 1998. "Asset pricing in production economies," Journal of Monetary Economics, Elsevier, Elsevier, vol. 41(2), pages 257-275, April.
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Cited by:
  1. Addessi, William & Busato, Francesco, 2009. "Fair wages, labor relations and asset returns," Journal of Financial Stability, Elsevier, Elsevier, vol. 5(4), pages 410-430, December.

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