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Corporate earnings and the equity premium

  • Longstaff, Francis A.
  • Piazzesi, Monika

Corporate cash flows are highly volatile and strongly procyclical. We examine the asset-pricing implications of the sensitivity of corporate cash flows to economic shocks within a continuous-time model in which dividends are a stochastic fraction of aggregate consumption. We provide closed-form solutions for stock values and show that the equity premium can be represented as the sum of three components which we call the consumption-risk, event-risk, and corporate-risk premia. Calibrating to historical data, we show that the model implies a total equity premium many times larger than in the standard model. The model also generates levels of equity volatility consistent with those experienced in the stock market.

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Article provided by Elsevier in its journal Journal of Financial Economics.

Volume (Year): 74 (2004)
Issue (Month): 3 (December)
Pages: 401-421

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Handle: RePEc:eee:jfinec:v:74:y:2004:i:3:p:401-421
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505576

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