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Corporate Earnings and the Equity Premium

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  • Francis Longstaff
  • Monika Piazzesi

Abstract

Corporate cash flows are highly volatile and strongly procyclical. We examine the asset-pricing implications of the sensitivity of corporate cash flows to economic shocks within a continuous-time model in which dividends are a stochastic fraction of aggregate consumption. We provide closed-form solutions for stock values and show that the equity premium can be represented as the sum of three components which we call the consumption-risk, event-risk, and corporate-risk premia. Calibrating to historical data, we show that the model implies a total equity premium many times larger than in the standard model. The model also generates levels of equity volatility consistent with those experienced in the stock market.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 10054.

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Date of creation: Oct 2003
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Publication status: published as Longstaff, Francis A. and Monika Piazzesi. "Corporate Earnings And The Equity Premium," Journal of Financial Economics, 2004, v74(3,Dec), 401-421.
Handle: RePEc:nbr:nberwo:10054

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