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The Equity Premium Implied by Production

  • Urban Jermann

This paper studies the determinants of the equity premium as implied by producers' first-order conditions. A closed form expression is presented for the Sharpe ratio at steady-state as a function of investment volatility and adjustment cost curvature. Calibrated to the U.S. postwar economy, the model can generate a sizeable equity premium, with reasonable volatility for market returns and risk free rates. The market's Sharpe ratio and the market price of risk are very volatile. Contrary to most models, the model generates a negative correlation between conditional means and standard deviations of aggregate excess returns.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 12487.

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Date of creation: Aug 2006
Date of revision:
Publication status: published as Jermann, Urban. "The Equity Premium Implied by Production." Journal of Financial Economics. Volume 98, Issue 2, November 2010, Pages 279-296
Handle: RePEc:nbr:nberwo:12487
Note: AP
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  8. Fumio Hayashi, 1981. "Tobin's Marginal q and Average a : A Neoclassical Interpretation," Discussion Papers 457, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  9. Brandt, Michael W. & Kang, Qiang, 2004. "On the relationship between the conditional mean and volatility of stock returns: A latent VAR approach," Journal of Financial Economics, Elsevier, vol. 72(2), pages 217-257, May.
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  18. G. Constantinides, 1990. "Habit formation: a resolution of the equity premium puzzle," Levine's Working Paper Archive 1397, David K. Levine.
  19. Robert E. Hall, 2004. "Measuring Factor Adjustment Costs," The Quarterly Journal of Economics, MIT Press, vol. 119(3), pages 899-927, August.
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