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The Equity Premium and the Business Cycle: the Role of Demand and Supply Shocks

  • Smith, Peter N
  • Sorensen, Steffen
  • Wickens, Michael R.

This paper explores the effects of the US business cycle on US stock market returns through an analysis of the equity risk premium. We propose a new methodology based on the SDF approach to asset pricing that allows us to uncover the different effects of aggregate demand and supply shocks. We find that negative shocks are more important that positive shocks, and that supply shocks have a much greater impact than demand shocks.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7227.

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Date of creation: Mar 2009
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Handle: RePEc:cpr:ceprdp:7227
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  1. Geert Bekaert & Guojun Wu, 1997. "Asymmetric Volatility and Risk in Equity Markets," NBER Working Papers 6022, National Bureau of Economic Research, Inc.
  2. Harvey, Campbell R., 1989. "Time-varying conditional covariances in tests of asset pricing models," Journal of Financial Economics, Elsevier, vol. 24(2), pages 289-317.
  3. G. William Schwert, 1990. "Why Does Stock Market Volatility Change Over Time?," NBER Working Papers 2798, National Bureau of Economic Research, Inc.
  4. Scruggs, John T. & Glabadanidis, Paskalis, 2003. "Risk Premia and the Dynamic Covariance between Stock and Bond Returns," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 38(02), pages 295-316, June.
  5. Baillie, R.T. & Degennaro, R.P., 1988. "Stock Returns And Volatility," Papers 8803, Michigan State - Econometrics and Economic Theory.
  6. French, Kenneth R. & Schwert, G. William & Stambaugh, Robert F., 1987. "Expected stock returns and volatility," Journal of Financial Economics, Elsevier, vol. 19(1), pages 3-29, September.
  7. Peter N Smith & Michael R Wickens, . "Asset Pricing with Observable Stochastic Discount Factors," Discussion Papers 02/03, Department of Economics, University of York.
  8. Keating, John W., 2000. "Macroeconomic Modeling with Asymmetric Vector Autoregressions," Journal of Macroeconomics, Elsevier, vol. 22(1), pages 1-28, January.
  9. Chauvet, Marcelle & Potter, Simon, 2001. "Nonlinear Risk," Macroeconomic Dynamics, Cambridge University Press, vol. 5(04), pages 621-646, September.
  10. G. William Schwert, 1998. "Stock Market Volatility: Ten Years After the Crash," NBER Working Papers 6381, National Bureau of Economic Research, Inc.
  11. Paul Harrison & Harold H. Zhang, 1999. "An Investigation Of The Risk And Return Relation At Long Horizons," The Review of Economics and Statistics, MIT Press, vol. 81(3), pages 399-408, August.
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