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Taxes, regulations, and asset prices

  • Ellen R. McGrattan
  • Edward C. Prescott

U.S. stock prices have increased much faster than gross domestic product GDP) in the postwar period. Between 1962 and 2000, corporate equity value relative to GDP nearly doubled. In this paper, we determine what standard growth theory says the equity value should be in 1962 and 2000, the two years for which our steady-state assumption is a reasonable one. We find that the actual valuations were close to the theoretical predictions in both years. The reason for the large run-up in equity value relative to GDP is that the average tax rate on dividends fell dramatically between 1962 and 2000. We also find that, given legal constraints that effectively prohibited the holding of stocks as reserves for pension plans, there is no equity premium puzzle in the postwar period. The average returns on debt and equity are as theory predicts.

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Paper provided by Federal Reserve Bank of Minneapolis in its series Working Papers with number 610.

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Date of creation: 2001
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Publication status: Published in Federal Reserve Bank of Minneapolis Staff Report 309
Handle: RePEc:fip:fedmwp:610
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  9. Feldstein, Martin, 1980. "Inflation, tax rules and the stock market," Journal of Monetary Economics, Elsevier, vol. 6(3), pages 309-331, July.
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  13. Heaton, John & Lucas, Deborah J, 1996. "Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing," Journal of Political Economy, University of Chicago Press, vol. 104(3), pages 443-87, June.
  14. Gali, Jordi, 1994. "Keeping Up with the Joneses: Consumption Externalities, Portfolio Choice, and Asset Prices," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 26(1), pages 1-8, February.
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  17. George M. Constantinides & John B. Donaldson & Rajnish Mehra, . "Junior Can't borrow: A New Perspective on the Equity Premium Puzzle."," CRSP working papers 457, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  18. 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.
  19. Ellen R. McGrattan & Edward C. Prescott, 2001. "Is the Stock Market Overvalued?," NBER Working Papers 8077, National Bureau of Economic Research, Inc.
  20. Kurz, M. & Beltratti, A., 1996. "The Equity Premium Is No Puzzle," Papers 282, Banca Italia - Servizio di Studi.
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