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The Declining U.S. Equity Premium

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  • Ravi Jagannathan
  • Ellen R. McGrattan
  • Anna Scherbina

Abstract

This study demonstrates that the U.S. equity premium has declined significantly during the last three decades. The study calculates the equity premium using a variation of a formula in the classic Gordon stock valuation model. The calculation includes the bond yield, the stock dividend yield, and the expected dividend growth rate, which in this formulation can change over time. The study calculates the premium for several measures of the aggregate U.S. stock portfolio and several assumptions about bond yields and stock dividends and gets basically the same result. The premium averaged about 7 percentage points during 1926 70 and only about 0.7 of a percentage point after that. This result is shown to be reasonable by demonstrating the roughly equal returns that investments in stocks and consol bonds of the same duration would have earned between 1982 and 1999, years when the equity premium is estimated to have been zero.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 8172.

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Date of creation: Mar 2001
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Handle: RePEc:nbr:nberwo:8172

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  1. John H. Cochrane, 1997. "Where is the market going? Uncertain facts and novel theories," Economic Perspectives, Federal Reserve Bank of Chicago, issue Nov, pages 3-37.
  2. Lars Peter Hansen & Ravi Jagannathan, 1990. "Implications of security market data for models of dynamic economies," Discussion Paper / Institute for Empirical Macroeconomics 29, Federal Reserve Bank of Minneapolis.
  3. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
  4. John Y. Campbell & Robert J. Shiller, 1989. "The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors," NBER Working Papers 2100, National Bureau of Economic Research, Inc.
  5. Merton, Robert C., 1987. "A simple model of capital market equilibrium with incomplete information," Working papers 1869-87., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  6. Welch, Ivo, 2000. "Views of Financial Economists on the Equity Premium and on Professional Controversies," The Journal of Business, University of Chicago Press, vol. 73(4), pages 501-37, October.
  7. Olivier J. Blanchard, 1993. "Movements in the Equity Premium," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 24(2), pages 75-138.
  8. Kocherlakota, N., 1995. "The Equity Premium: It's Still a Puzzle," Working Papers 95-05, University of Iowa, Department of Economics.
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