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The Equity Premium Implied by Production

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  • Urban J. 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 Society for Economic Dynamics in its series 2005 Meeting Papers with number 630.

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Date of creation: 2005
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Handle: RePEc:red:sed005:630

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Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
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Web page: http://www.EconomicDynamics.org/society.htm
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Citations

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Cited by:
  1. 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.
  2. David N. DeJong & Emilio Espino, 2007. "The Cyclical Behavior of Equity Turnover," Working Papers 294, University of Pittsburgh, Department of Economics, revised Oct 2007.
  3. Jermann, Urban J., 2013. "A production-based model for the term structure," Journal of Financial Economics, Elsevier, vol. 109(2), pages 293-306.
  4. Emilio Espino, 2005. "Equilibrium Portfolios in the Neoclassical Growth Model," Working Papers 87, Universidad de San Andres, Departamento de Economia, revised Dec 2005.
  5. Olaf Posch, 2010. "Risk Premia in General Equilibrium," CESifo Working Paper Series 3131, CESifo Group Munich.
  6. Urban Jermann, 2013. "A Production-Based Model for the Term Structure," NBER Working Papers 18774, National Bureau of Economic Research, Inc.
  7. Andrew Y. Chen, 2013. "External Habit in a Production Economy," 2013 Papers pch1244, Job Market Papers.
  8. 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.
  9. Cochrane, John H., 2005. "Financial Markets and the Real Economy," Foundations and Trends(R) in Finance, now publishers, vol. 1(1), pages 1-101, July.
  10. Leung, Charles Ka Yui & Teo, Wing Leong, 2010. "Should the optimal portfolio be region-specific? A multi-region model with monetary policy and asset price co-movements," MPRA Paper 28216, University Library of Munich, Germany.
  11. Frederico Belo & Chen Xue & Lu Zhang, 2010. "Cross-sectional Tobin's Q," NBER Working Papers 16336, National Bureau of Economic Research, Inc.
  12. Francois Gourio, 2007. "Putty-Clay Technology And Stock Market Volatility," Boston University - Department of Economics - Working Papers Series WP2007-005, Boston University - Department of Economics.
  13. Lin, Xiaoji & Zhang, Lu, 2013. "The investment manifesto," Journal of Monetary Economics, Elsevier, vol. 60(3), pages 351-366.

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