IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this paper or follow this series

Corporate Earnings and the Equity Premium

  • Longstaff, Francis
  • Piazzesi, Monika
Registered author(s):

    Economic shocks affect corporate cash flows far more than they do aggregate consumption. We examine the asset-pricing implications of corporate sensitivity to shocks using a continuous-time representative agent framework in which earnings are a stochastic fraction of total consumption. We provide closed-form solutions for equity values when earnings and consumption follow exponential-affine jump-diffusion processes. Calibrating the model to historical data, we show that the extreme sensitivity of corporate cash flows to shocks dramatically increases the equity premium. The model implies realistic values for the equity premium given modest levels of risk aversion and generates levels of equity volatility consistent with those experienced by the stock

    If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

    File URL: http://www.escholarship.org/uc/item/3qn115m4.pdf;origin=repeccitec
    Download Restriction: no

    Paper provided by Anderson Graduate School of Management, UCLA in its series University of California at Los Angeles, Anderson Graduate School of Management with number qt3qn115m4.

    as
    in new window

    Length:
    Date of creation: 01 Sep 2002
    Date of revision:
    Handle: RePEc:cdl:anderf:qt3qn115m4
    Contact details of provider: Postal: 110 Westwood Plaza, Los Angeles, CA. 90095
    Web page: http://www.escholarship.org/repec/anderson_fin/

    More information through EDIRC

    References listed on IDEAS
    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

    as in new window
    1. John Y. Campbell, 1987. "Bond and Stock Returns in a Simple Exchange Model," NBER Working Papers 1509, National Bureau of Economic Research, Inc.
    2. Sundaresan, Suresh M, 1989. "Intertemporally Dependent Preferences and the Volatility of Consumption and Wealth," Review of Financial Studies, Society for Financial Studies, vol. 2(1), pages 73-89.
    3. Andrew B. Abel, 1990. "Asset Prices under Habit Formation and Catching up with the Joneses," NBER Working Papers 3279, National Bureau of Economic Research, Inc.
    4. John H Cochrane, 2003. "Where is the Market Going: Uncertain Facts and Novel Theories," Levine's Working Paper Archive 618897000000000762, David K. Levine.
    5. Weil, Philippe, 1989. "The equity premium puzzle and the risk-free rate puzzle," Journal of Monetary Economics, Elsevier, vol. 24(3), pages 401-421, November.
    6. Merton, Robert C., 1971. "Optimum consumption and portfolio rules in a continuous-time model," Journal of Economic Theory, Elsevier, vol. 3(4), pages 373-413, December.
    7. Naik, Vasanttilak & Lee, Moon, 1990. "General Equilibrium Pricing of Options on the Market Portfolio with Discontinuous Returns," Review of Financial Studies, Society for Financial Studies, vol. 3(4), pages 493-521.
    8. Lettau, Martin & Ludvigson, Sydney, 2002. "Expected Returns and Expected Dividend Growth," CEPR Discussion Papers 3507, C.E.P.R. Discussion Papers.
    9. Philippe Jorion & William N. Goetzmann, 1999. "Global Stock Markets in the Twentieth Century," Journal of Finance, American Finance Association, vol. 54(3), pages 953-980, 06.
    10. Harry Mamaysky, 2002. "A Model for Pricing Stocks and Bonds with Default Risk," Yale School of Management Working Papers ysm286, Yale School of Management.
    11. Ellen R. McGrattan & Edward C. Prescott, 2001. "Taxes, Regulations, and Asset Prices," NBER Working Papers 8623, National Bureau of Economic Research, Inc.
    12. S.G. Cecchetti & P. Lam & N.C. Mark, 2010. "The equity premium and the risk-free rate: matching the moments," Levine's Working Paper Archive 1396, David K. Levine.
    13. Detemple, Jerome B & Zapatero, Fernando, 1991. "Asset Prices in an Exchange Economy with Habit Formation," Econometrica, Econometric Society, vol. 59(6), pages 1633-57, November.
    14. Lior Menzly & Tano Santos & Pietro Veronesi, 2002. "The Time Series of the Cross Section of Asset Prices," NBER Working Papers 9217, National Bureau of Economic Research, Inc.
    15. Zengjing Chen & Larry G. Epstein, 2000. "Ambiguity, risk and asset returns in continuous time," RCER Working Papers 474, University of Rochester - Center for Economic Research (RCER).
    16. Kocherlakota, N., 1995. "The Equity Premium: It's Still a Puzzle," Working Papers 95-05, University of Iowa, Department of Economics.
    17. Martin Lettau & Harald Uhlig, 2000. "Can Habit Formation be Reconciled with Business Cycle Facts?," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 3(1), pages 79-99, January.
    18. Harry Mamaysky, 2002. "A Model For Pricing Stocks and Bonds," Yale School of Management Working Papers ysm279, Yale School of Management, revised 01 Jun 2002.
    19. Nicholas Barberis & Ming Huang, 2001. "Mental Accounting, Loss Aversion, and Individual Stock Returns," NBER Working Papers 8190, National Bureau of Economic Research, Inc.
    20. John Y. Campbell & John H. Cochrane, 1994. "By force of habit: a consumption-based explanation of aggregate stock market behavior," Working Papers 94-17, Federal Reserve Bank of Philadelphia.
    21. Hansen, Lars Peter & Sargent, Thomas J & Tallarini, Thomas D, Jr, 1999. "Robust Permanent Income and Pricing," Review of Economic Studies, Wiley Blackwell, vol. 66(4), pages 873-907, October.
    22. Gurdip S. Bakshi & Zhiwu Chen, 1996. "An Alternative Valuation Model for Contingent Claims," Yale School of Management Working Papers ysm78, Yale School of Management.
    23. Robert E. Hall, 2001. "The Stock Market and Capital Accumulation," American Economic Review, American Economic Association, vol. 91(5), pages 1185-1202, December.
    24. Tano Santos & Pietro Veronesi, 2001. "Labor Income and Predictable Stock Returns," NBER Working Papers 8309, National Bureau of Economic Research, Inc.
    25. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
    26. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
    27. Andrew B. Abel, 1998. "Risk Premia and Term Premia in General Equilibrium," NBER Working Papers 6683, National Bureau of Economic Research, Inc.
    28. David A. Chapman, 1998. "Habit Formation and Aggregate Consumption," Econometrica, Econometric Society, vol. 66(5), pages 1223-1230, September.
    29. Breeden, Douglas T., 1979. "An intertemporal asset pricing model with stochastic consumption and investment opportunities," Journal of Financial Economics, Elsevier, vol. 7(3), pages 265-296, September.
    30. J. Nellie Liang & Steven A. Sharpe, 1999. "Share repurchases and employee stock options and their implications for S&P 500 share retirements and expected returns," Finance and Economics Discussion Series 1999-59, Board of Governors of the Federal Reserve System (U.S.).
    31. Ivo Welch, 2001. "The Equity Premium Consensus Forecast Revisited," Cowles Foundation Discussion Papers 1325, Cowles Foundation for Research in Economics, Yale University.
    32. Constantinides, George M, 1990. "Habit Formation: A Resolution of the Equity Premium Puzzle," Journal of Political Economy, University of Chicago Press, vol. 98(3), pages 519-43, June.
    33. Brennan, Michael J. & Xia, Yihong, 2001. "Stock price volatility and equity premium," Journal of Monetary Economics, Elsevier, vol. 47(2), pages 249-283, April.
    Full references (including those not matched with items on IDEAS)

    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

    When requesting a correction, please mention this item's handle: RePEc:cdl:anderf:qt3qn115m4. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Lisa Schiff)

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.