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The Equity Premium Implied by Production

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  • Urban Jermann

Abstract

This paper studies the determinants of the equity premium as implied by producers’ first-order conditions. A closed form expression is presented for the Sharpe ratio at steady-state as a function of investment volatility and adjustment cost curvature. Calibrated to the U.S. postwar economy, the model can generate a sizeable equity premium, with reasonable volatility for market returns and risk free rates. The market’s Sharpe ratio and the market price of risk are very volatile. Contrary to most models, the model generates a negative correlation between conditional means and standard deviations of aggregate excess returns.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 12487.

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Date of creation: Aug 2006
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Publication status: published as Jermann, Urban. "The Equity Premium Implied by Production." Journal of Financial Economics. Volume 98, Issue 2, November 2010, Pages 279-296
Handle: RePEc:nbr:nberwo:12487

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Cited by:
  1. Leung, Charles Ka Yui & Teo, Wing Leong, 2011. "Should the optimal portfolio be region-specific? A multi-region model with monetary policy and asset price co-movements," Regional Science and Urban Economics, Elsevier, vol. 41(3), pages 293-304, May.
  2. Balvers, Ronald J. & Huang, Dayong, 2007. "Productivity-based asset pricing: Theory and evidence," Journal of Financial Economics, Elsevier, vol. 86(2), pages 405-445, November.
  3. Lin, Xiaoji & Zhang, Lu, 2013. "The investment manifesto," Journal of Monetary Economics, Elsevier, vol. 60(3), pages 351-366.
  4. David N. DeJong & Emilio Espino, 2007. "The Cyclical Behavior of Equity Turnover," Working Papers 294, University of Pittsburgh, Department of Economics, revised Oct 2007.
  5. Gourio, François, 2011. "Putty-clay technology and stock market volatility," Journal of Monetary Economics, Elsevier, vol. 58(2), pages 117-131, March.
  6. Frederico Belo & Chen Xue & Lu Zhang, 2010. "Cross-sectional Tobin's Q," NBER Working Papers 16336, National Bureau of Economic Research, Inc.
  7. Olaf Posch, 2010. "Risk Premia in General Equilibrium," CESifo Working Paper Series 3131, CESifo Group Munich.
  8. Andrew Y. Chen, 2013. "External Habit in a Production Economy," 2013 Papers pch1244, Job Market Papers.
  9. John Cochrane, 2005. "Financial Markets and the Real Economy," NBER Working Papers 11193, National Bureau of Economic Research, Inc.
  10. Espino, Emilio, 2007. "Equilibrium portfolios in the neoclassical growth model," Journal of Economic Theory, Elsevier, vol. 137(1), pages 673-687, November.
  11. Urban Jermann, 2013. "A Production-Based Model for the Term Structure," NBER Working Papers 18774, National Bureau of Economic Research, Inc.
  12. Mele, Antonio, 2007. "Asymmetric stock market volatility and the cyclical behavior of expected returns," Journal of Financial Economics, Elsevier, vol. 86(2), pages 446-478, November.
  13. Jermann, Urban J., 2013. "A production-based model for the term structure," Journal of Financial Economics, Elsevier, vol. 109(2), pages 293-306.

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