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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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  1. João F. Gomes & Amir Yaron & Lu Zhang, 2006. "Asset Pricing Implications of Firms' Financing Constraints," Review of Financial Studies, Society for Financial Studies, vol. 19(4), pages 1321-1356.
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  15. Jermann, Urban J., 1998. "Asset pricing in production economies," Journal of Monetary Economics, Elsevier, vol. 41(2), pages 257-275, April.
  16. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
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Citations

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Cited by:
  1. Jermann, Urban J., 2013. "A production-based model for the term structure," Journal of Financial Economics, Elsevier, vol. 109(2), pages 293-306.
  2. 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.
  3. 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.
  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. Lin, Xiaoji & Zhang, Lu, 2013. "The investment manifesto," Journal of Monetary Economics, Elsevier, vol. 60(3), pages 351-366.
  6. Frederico Belo & Chen Xue & Lu Zhang, 2010. "Cross-sectional Tobin's Q," NBER Working Papers 16336, National Bureau of Economic Research, Inc.
  7. John Cochrane, 2005. "Financial Markets and the Real Economy," NBER Working Papers 11193, National Bureau of Economic Research, Inc.
  8. Gourio, François, 2011. "Putty-clay technology and stock market volatility," Journal of Monetary Economics, Elsevier, vol. 58(2), pages 117-131, March.
  9. Olaf Posch, 2009. "Risk premia in general equilibrium," CREATES Research Papers 2009-58, School of Economics and Management, University of Aarhus.
  10. Emilio Espino, 2005. "Equilibrium Portfolios in the Neoclassical Growth Model," Working Papers 87, Universidad de San Andres, Departamento de Economia, revised Dec 2005.
  11. Ronald J. Balvers & Dayong Huang, 2005. "Productivity-Based Asset Pricing: Theory and Evidence," Working Papers 05-05 Classification- JEL, Department of Economics, West Virginia University.
  12. Urban Jermann, 2013. "A Production-Based Model for the Term Structure," NBER Working Papers 18774, National Bureau of Economic Research, Inc.
  13. Andrew Y. Chen, 2013. "External Habit in a Production Economy," 2013 Papers pch1244, Job Market Papers.

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