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Corporate Earnings and the Equity Premium

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  • Francis Longstaff
  • Monika Piazzesi

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.

Suggested Citation

  • Francis Longstaff & Monika Piazzesi, 2003. "Corporate Earnings and the Equity Premium," NBER Working Papers 10054, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:10054
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    JEL classification:

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

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