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The Equity Premium Implied by Production

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Author Info
Urban Jermann

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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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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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Handle: RePEc:nbr:nberwo:12487

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Find related papers by JEL classification:
E23 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Production
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing

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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.:
  1. John H. Cochrane, 1988. "Production Based Asset Pricing," NBER Working Papers 2776, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  2. 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. [Downloadable!]
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  3. Cochrane, John H, 1991. " Production-Based Asset Pricing and the Link between Stock Returns and Economic Fluctuations," Journal of Finance, American Finance Association, vol. 46(1), pages 209-37, March. [Downloadable!] (restricted)
  4. 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.
    Other versions:
  5. Joao F. Gomes, 2001. "Financing Investment," American Economic Review, American Economic Association, vol. 91(5), pages 1263-1285, December. [Downloadable!] (restricted)
  6. Greenwood, Jeremy & Hercowitz, Zvi & Krusell, Per, 1997. "Long-Run Implications of Investment-Specific Technological Change," American Economic Review, American Economic Association, vol. 87(3), pages 342-62, June. [Downloadable!] (restricted)
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  7. Joao Gomes & Amir Yaron & Lu Zhang, 2002. "Asset Pricing Implications of Firms' Financing Constraints," NBER Working Papers 9365, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  8. Jermann, Urban J., 1998. "Asset pricing in production economies," Journal of Monetary Economics, Elsevier, vol. 41(2), pages 257-275, April. [Downloadable!] (restricted)
  9. John Y. Campbell & John Cochrane, 1999. "Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," Journal of Political Economy, University of Chicago Press, vol. 107(2), pages 205-251, April. [Downloadable!] (restricted)
  10. Abel, Andrew B & Eberly, Janice C, 1994. "A Unified Model of Investment under Uncertainty," American Economic Review, American Economic Association, vol. 84(5), pages 1369-84, December. [Downloadable!] (restricted)
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  11. Julien Hugonnier & Erwan Morellec & Suresh Sundaresan, 2005. "Growth Options in General Equilibrium: Some Asset Pricing Implications," FAME Research Paper Series rp138, International Center for Financial Asset Management and Engineering. [Downloadable!]
  12. Constantinides, George M, 1990. "Habit Formation: A Resolution of the Equity Premium Puzzle," Journal of Political Economy, University of Chicago Press, vol. 98(3), pages 519-43, June. [Downloadable!] (restricted)
  13. Luigi Guiso & Giuseppe Parigi, 1999. "Investment And Demand Uncertainty," The Quarterly Journal of Economics, MIT Press, vol. 114(1), pages 185-227, February. [Downloadable!] (restricted)
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  14. Hayashi, Fumio, 1982. "Tobin's Marginal q and Average q: A Neoclassical Interpretation," Econometrica, Econometric Society, vol. 50(1), pages 213-24, January. [Downloadable!] (restricted)
    Other versions:
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Cited by:
(explanations, 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.)

  1. David N. DeJong & Emilio Espino, 2007. "The Cyclical Behavior of Equity Turnover," Working Papers 294, University of Pittsburgh, Department of Economics, revised Sep 2009. [Downloadable!]
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This page was last updated on 2009-11-25.

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