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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 National Bureau of Economic Research, Inc in its series NBER Working Papers with number 8623.

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Date of creation: Dec 2001
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Handle: RePEc:nbr:nberwo:8623
Note: AP EFG
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  3. George M. Constantinidies & John B. Donaldson & Rajnish Mehra, 1998. "Junior Can't Borrow: A New Perspective on the Equity Premium Puzzle," NBER Working Papers 6617, National Bureau of Economic Research, Inc.
  4. Feldstein, Martin & Green, Jerry, 1983. "Why Do Companies Pay Dividends?," Scholarly Articles 3204679, Harvard University Department of Economics.
  5. 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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  7. Michele Boldrin & Lawrence J. Christiano & Jonas D.M. Fisher, 1995. "Asset Pricing Lessons for Modeling Business Cycles," NBER Working Papers 5262, National Bureau of Economic Research, Inc.
  8. Fernando Alvarez & Urban J. Jermann, . "Quantitative Asset Pricing Implications of Endogenous Solvency Constraints," Rodney L. White Center for Financial Research Working Papers 10-99, Wharton School Rodney L. White Center for Financial Research.
  9. A. Abel, 2010. "Asset prices under habit formation and catching up with the Jones," Levine's Working Paper Archive 1395, David K. Levine.
  10. Ellen R. McGrattan & Edward C. Prescott, 2001. "Is the Stock Market Overvalued?," NBER Working Papers 8077, National Bureau of Economic Research, Inc.
  11. Martin Feldstein, 1983. "Inflation and the Stock Market," NBER Chapters, in: Inflation, Tax Rules, and Capital Formation, pages 186-198 National Bureau of Economic Research, Inc.
  12. 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.
  13. Robert E. Hall, 2000. "The stock market and capital accumulation," Proceedings, Federal Reserve Bank of San Francisco, issue Apr.
  14. Cochrane, John H, 1991. " Production-Based Asset Pricing and the Link between Stock Returns and Economic Fluctuations," Journal of Finance, American Finance Association, vol. 46(1), pages 209-37, March.
  15. 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.
  16. Bansal, Ravi & Coleman, Wilbur John, II, 1996. "A Monetary Explanation of the Equity Premium, Term Premium, and Risk-Free Rate Puzzles," Journal of Political Economy, University of Chicago Press, vol. 104(6), pages 1135-71, December.
  17. Lawrence H. Summers, 1981. "Taxation and Corporate Investment: A q-Theory Approach," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 12(1), pages 67-140.
  18. Gali, J., 1992. "Keeping Up with the Joneses: Consumption Externalities, Portfolio Choice and Asset Prices," Papers 92-22, Columbia - Graduate School of Business.
  19. John Y. Campbell & Robert J. Shiller, 2001. "Valuation Ratios and the Long-Run Stock Market Outlook: An Update," NBER Working Papers 8221, National Bureau of Economic Research, Inc.
  20. Jermann, Urban J., 1998. "Asset pricing in production economies," Journal of Monetary Economics, Elsevier, vol. 41(2), pages 257-275, April.
  21. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
  22. Epstein, Larry G & Zin, Stanley E, 1989. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework," Econometrica, Econometric Society, vol. 57(4), pages 937-69, July.
  23. John H. Cochrane, 1988. "Production Based Asset Pricing," NBER Working Papers 2776, National Bureau of Economic Research, Inc.
  24. John Y. Campbell & John Cochrane, 1999. "Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," Journal of Political Economy, University of Chicago Press, vol. 107(2), pages 205-251, April.
  25. James M. Poterba & Lawrence H. Summers, 1985. "The Economic Effects of Dividend Taxation," NBER Working Papers 1353, National Bureau of Economic Research, Inc.
  26. Kurz, M. & Beltratti, A., 1996. "The Equity Premium Is No Puzzle," Papers 282, Banca Italia - Servizio di Studi.
  27. Auerbach, Alan J, 1979. "Wealth Maximization and the Cost of Capital," The Quarterly Journal of Economics, MIT Press, vol. 93(3), pages 433-46, August.
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