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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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File URL: http://repec.org/sed2005/up.20222.1107181013.pdf
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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
Fax: 1-314-444-8731
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Web page: http://www.EconomicDynamics.org/society.htm
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  1. Cochrane, John H, 1991. " Production-Based Asset Pricing and the Link between Stock Returns and Economic Fluctuations," Journal of Finance, American Finance Association, American Finance Association, vol. 46(1), pages 209-37, March.
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  16. Jermann, Urban J., 1998. "Asset pricing in production economies," Journal of Monetary Economics, Elsevier, Elsevier, vol. 41(2), pages 257-275, April.
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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, Elsevier, vol. 86(2), pages 405-445, November.
  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. Gourio, François, 2011. "Putty-clay technology and stock market volatility," Journal of Monetary Economics, Elsevier, Elsevier, vol. 58(2), pages 117-131, March.
  4. Espino, Emilio, 2007. "Equilibrium portfolios in the neoclassical growth model," Journal of Economic Theory, Elsevier, vol. 137(1), pages 673-687, November.
  5. Posch, Olaf, 2011. "Risk premia in general equilibrium," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 35(9), pages 1557-1576, September.
  6. Lin, Xiaoji & Zhang, Lu, 2013. "The investment manifesto," Journal of Monetary Economics, Elsevier, Elsevier, vol. 60(3), pages 351-366.
  7. John Cochrane, 2005. "Financial Markets and the Real Economy," NBER Working Papers 11193, National Bureau of Economic Research, Inc.
  8. Mele, Antonio, 2007. "Asymmetric stock market volatility and the cyclical behavior of expected returns," Journal of Financial Economics, Elsevier, Elsevier, vol. 86(2), pages 446-478, November.
  9. Andrew Y. Chen, 2013. "External Habit in a Production Economy," 2013 Papers, Job Market Papers pch1244, Job Market Papers.
  10. Urban Jermann, 2013. "A Production-Based Model for the Term Structure," NBER Working Papers 18774, National Bureau of Economic Research, Inc.
  11. David N. DeJong & Emilio Espino, 2007. "The Cyclical Behavior of Equity Turnover," Working Papers, University of Pittsburgh, Department of Economics 294, University of Pittsburgh, Department of Economics, revised Oct 2007.
  12. Frederico Belo & Chen Xue & Lu Zhang, 2010. "Cross-sectional Tobin's Q," NBER Working Papers 16336, National Bureau of Economic Research, Inc.
  13. Jermann, Urban J., 2013. "A production-based model for the term structure," Journal of Financial Economics, Elsevier, Elsevier, vol. 109(2), pages 293-306.

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