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Earnings Inequality and the Equity Premium

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  • Walentin Karl

    () (Sveriges Riksbank)

Abstract

In this paper, we document a 75 percent increase in stockholders' share of aggregate labor income in the U.S. from 1962 to 2000 using data from Survey of Consumer Finances. Our decomposition of the increase in stockholders' share of aggregate labor income documents that one half is due to the equi-proportional increase in participation and one quarter each is due to the non-proportional part of the changes in stockmarket participation and changes in the income distribution, respectively. The change due to the labor income distribution is driven entirely by the increase in the share of labor income accounted for by the top labor income decile. Using a simple model with limited stockmarket participation, we present a mechanism for how the increase in stockholders' share of aggregate labor income has affected the ex ante equity premium (i.e. the discount rate applied to equity). The mechanism works through the composition of income of stockholders. The resulting decrease in the equity premium is 44 percent, which roughly coincides with the historical change in the post-1951 equity premium implied by the simple dividend growth model in Fama and French (2002).

Suggested Citation

  • Walentin Karl, 2010. "Earnings Inequality and the Equity Premium," The B.E. Journal of Macroeconomics, De Gruyter, vol. 10(1), pages 1-23, November.
  • Handle: RePEc:bpj:bejmac:v:10:y:2010:i:1:n:36
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    Cited by:

    1. Kevin J. Lansing, 2011. "Asset pricing with concentrated ownership of capital," Working Paper 2011/18, Norges Bank.
    2. Yulei Peng & Anastasia Zervou, 2014. "Monetary Policy Rules and the Equity Premium," Working Papers 20141115_001, Texas A&M University, Department of Economics.
    3. Zervou, Anastasia S., 2013. "Financial market segmentation, stock market volatility and the role of monetary policy," European Economic Review, Elsevier, vol. 63(C), pages 256-272.
    4. Favilukis, Jack, 2013. "Inequality, stock market participation, and the equity premium," Journal of Financial Economics, Elsevier, vol. 107(3), pages 740-759.
    5. repec:eee:eecrev:v:103:y:2018:i:c:p:39-59 is not listed on IDEAS

    More about this item

    JEL classification:

    • D31 - Microeconomics - - Distribution - - - Personal Income and Wealth Distribution
    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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