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Taxes, Regulations, and Asset Prices

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Author Info
Ellen R. McGrattan
Edward C. Prescott

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Abstract

U.S. stock prices have increased much faster than gross domestic product (GDP) in the postwar period. Between 1962 and 2000, corporate equity value relative to GDP nearly doubled. In this paper, we determine what standard growth theory says the equity value should be in 1962 and 2000, the two years for which our steady-state assumption is a reasonable one. We find that the actual valuations were close to the theoretical predictions in both years. The reason for the large run-up in equity value relative to GDP is that the average tax rate on dividends fell dramatically between 1962 and 2000. We also find that, given legal constraints that effectively prohibited the holding of stocks as reserves for pension plans, there is no equity premium puzzle in the postwar period. The average returns on debt and equity are as theory predicts.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 8623.

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Date of creation: Dec 2001
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Handle: RePEc:nbr:nberwo:8623

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Find related papers by JEL classification:
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General

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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. 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)
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    Other versions:
  3. 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:
  4. Feldstein, Martin & Green, Jerry, 1983. "Why Do Companies Pay Dividends?," American Economic Review, American Economic Association, vol. 73(1), pages 17-30, March. [Downloadable!] (restricted)
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  5. Feldstein, Martin, 1980. "Inflation and the Stock Market," American Economic Review, American Economic Association, vol. 70(5), pages 839-47, December. [Downloadable!] (restricted)
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  6. Lawrence H. Summers, 1981. "Taxation and Corporate Investment: A q-Theory Approach," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 12(1981-1), pages 67-140. [Downloadable!]
  7. Robert E. Hall, 1999. "The Stock Market and Capital Accumulation," NBER Working Papers 7180, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  8. Michele Boldrin & Lawrence J. Christiano & Jonas D.M. Fisher, 1995. "Asset Pricing Lessons for Modeling Business Cycles," NBER Working Papers 5262, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  9. John H. Cochrane, 1988. "Production Based Asset Pricing," NBER Working Papers 2776, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  10. 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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  11. Martin Feldstein, 1980. "Inflation, Tax Rules, and the Stock Market," NBER Working Papers 0403, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  12. James M. Poterba & Lawrence H. Summers, 1985. "The Economic Effects of Dividend Taxation," NBER Working Papers 1353, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  13. Heaton, John & Lucas, Deborah J, 1996. "Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing," Journal of Political Economy, University of Chicago Press, vol. 104(3), pages 443-87, June. [Downloadable!] (restricted)
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  14. Ellen R. McGrattan & Edward C. Prescott, 2000. "Is the stock market overvalued?," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 20-40. [Downloadable!]
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  15. George M. Constantinides & John B. Donaldson & Rajnish Mehra, . "Junior Can't borrow: A New Perspective on the Equity Premium Puzzle."," CRSP working papers 457, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
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  16. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March. [Downloadable!] (restricted)
  17. Bansal, Ravi & Coleman, Wilbur John, II, 1996. "A Monetary Explanation of the Equity Premium, Term Premium, and Risk-Free Rate Puzzles," Journal of Political Economy, University of Chicago Press, vol. 104(6), pages 1135-71, December. [Downloadable!] (restricted)
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  21. 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)
  22. John Y. Campbell & Robert J. Shiller, 2001. "Valuation Ratios and the Long-run Stock Market Outlook: An Update," Cowles Foundation Discussion Papers 1295, Cowles Foundation, Yale University. [Downloadable!]
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  23. Auerbach, Alan J, 1979. "Wealth Maximization and the Cost of Capital," The Quarterly Journal of Economics, MIT Press, vol. 93(3), pages 433-46, August. [Downloadable!] (restricted)
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  24. 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)
Full references

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(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. M. Fatih Guvenen, 2003. "A Parsimonious Macroeconomic Model for Asset Pricing: Habit Formation or Cross-sectional Heterogeneity?," RCER Working Papers 499, University of Rochester - Center for Economic Research (RCER). [Downloadable!]
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  2. Tavares, Jose & Valkanov, Rossen, 2001. "The neglected effect of fiscal policy on stock and bond returns," FEUNL Working Paper Series wp413, Universidade Nova de Lisboa, Faculdade de Economia. [Downloadable!]
  3. Maasoumi, Esfandiar & Lim, G.C. & Martin, Vance, 2006. "A reexamination of the equity-premium puzzle: A robust non-parametric approach," Departmental Working Papers 0604, Southern Methodist University, Department of Economics. [Downloadable!]
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  4. Christophe Faugere & Julian Van Erlach, 2003. "The Equity Premium: Explained by GDP Growth and Consistent with Portfolio Insurance," Finance 0311004, EconWPA. [Downloadable!]
  5. Whelan, Shane, 2007. "Valuing Ireland's Pension System," Quarterly Economic Commentary: Special Articles, Economic and Social Research Institute (ESRI), vol. 2007(2-Summer), pages 55-80. [Downloadable!]
  6. Ricardo Lagos, 2006. "Asset prices and liquidity in an exchange economy," Staff Report 373, Federal Reserve Bank of Minneapolis. [Downloadable!]
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  7. Ellen R. McGrattan & Edward C. Prescott, 2004. "Taxes, Regulations, and the Value of U.S. and U.K. Corporations," Levine's Bibliography 122247000000000715, UCLA Department of Economics. [Downloadable!]
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  8. Rubens Penha Cysne, 2005. "Equity-Premium Puzzle: Evidence From Brazilian Data," Anais do XXXIII Encontro Nacional de Economia [Proceedings of the 33th Brazilian Economics Meeting] 088, ANPEC - Associação Nacional dos Centros de Pósgraduação em Economia [Brazilian Association of Graduate Programs in Economics]. [Downloadable!]
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  9. Vance Martin & G.C. Lim & Esfandiar Maasoumi, 2004. "Discounting The Equity Premium Puzzle," Econometric Society 2004 Australasian Meetings 331, Econometric Society. [Downloadable!]
  10. Rajnish Mehra & Edward C. Prescott, 2003. "The Equity Premium in Retrospect," NBER Working Papers 9525, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  11. Willi Semmler & Lars Grüne, 2004. "Asset Pricing with Delayed Consumption Decisions," Computing in Economics and Finance 2004 59, Society for Computational Economics. [Downloadable!]
  12. Robert J. Shiller, 2003. "From Efficient Markets Theory to Behavioral Finance," Journal of Economic Perspectives, American Economic Association, vol. 17(1), pages 83-104, Winter. [Downloadable!] (restricted)
    Other versions:
  13. Jakob B. Madsen & E. Philip Davis, 2004. "Equity Prices, Productivity Growth and 'The New Economy," FRU Working Papers 2004/11, University of Copenhagen. Department of Economics. Finance Research Unit. [Downloadable!]
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  14. Edward C. Prescott, 2003. "Non-convexities in quantitative general equilibrium studies of business cycles," Staff Report 312, Federal Reserve Bank of Minneapolis. [Downloadable!]
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  15. Francis Longstaff & Monika Piazzesi, 2003. "Corporate Earnings and the Equity Premium," NBER Working Papers 10054, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  16. George M. Constantinides, 2002. "Rational Asset Prices," NBER Working Papers 8826, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  17. Clemens Sialm, 2002. "Stochastic Taxation and Asset Pricing in Dynamic General Equilibrium," NBER Working Papers 9301, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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