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The long-run behavior of the S&P Composite Price Index and its risk premium


  • Cohen, Ruben D


We lay out here the basis for a long-term equity index model, with intent to extract the risk premium. This is done by first observing the behaviours of the S&P Composite price index, earnings and dividends over roughly 130 years of history, from 1871 to 1998, and then assessing whether they fit within an equilibrium and efficient-market framework. The notions of equilibrium and efficiency shall be defined and formalised here, as they relate to this work, using classical finance theory. The conclusions derived so far are twofold. First, there is a transition in the market’s behaviour at around 1945. It appears that prior to this, the dividend payment policy was, on aggregate, one of constant dividend yield. After this, the policy’s focus seems to have shifted towards achieving market equilibrium and efficiency. Second, the backward-looking risk premium during the post-transition period is found, in theory, to be simply the negative percent rate of change in dividend yield. Moreover, under the special-case scenario where the equity price is discounted at a constant “infinitehorizon” discount rate, the forward-looking risk premium becomes identically the dividend yield.

Suggested Citation

  • Cohen, Ruben D, 2000. "The long-run behavior of the S&P Composite Price Index and its risk premium," MPRA Paper 3192, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:3192

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    References listed on IDEAS

    1. Grossman, Sanford J & Shiller, Robert J, 1981. "The Determinants of the Variability of Stock Market Prices," American Economic Review, American Economic Association, vol. 71(2), pages 222-227, May.
    2. Campa, Jose M. & Chang, P. H. Kevin & Reider, Robert L., 1998. "Implied exchange rate distributions: evidence from OTC option markets1," Journal of International Money and Finance, Elsevier, vol. 17(1), pages 117-160, February.
    3. Shiller, Robert J, 1981. "Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?," American Economic Review, American Economic Association, vol. 71(3), pages 421-436, June.
    4. Finucane, Thomas J., 1991. "Put-Call Parity and Expected Returns," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 26(04), pages 445-457, December.
    5. Breeden, Douglas T & Litzenberger, Robert H, 1978. "Prices of State-contingent Claims Implicit in Option Prices," The Journal of Business, University of Chicago Press, vol. 51(4), pages 621-651, October.
    6. Campa, Jose Manuel & Chang, P. H. Kevin, 1998. "The forecasting ability of correlations implied in foreign exchange options," Journal of International Money and Finance, Elsevier, vol. 17(6), pages 855-880, December.
    7. Kleidon, Allan W, 1986. "Variance Bounds Tests and Stock Price Valuation Models," Journal of Political Economy, University of Chicago Press, vol. 94(5), pages 953-1001, October.
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    More about this item


    equity risk premium; S&P Composite Price Index; dividends; Gordon growth model;

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)


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