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Corporate earnings and the equity premium

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  • Longstaff, Francis A.
  • Piazzesi, Monika

Abstract

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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  • Longstaff, Francis A. & Piazzesi, Monika, 2004. "Corporate earnings and the equity premium," Journal of Financial Economics, Elsevier, vol. 74(3), pages 401-421, December.
    • Handle: RePEc:eee:jfinec:v:74:y:2004:i:3:p:401-421
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    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • E1 - Macroeconomics and Monetary Economics - - General Aggregative Models

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