IDEAS home Printed from https://ideas.repec.org/p/tin/wpaper/20180075.html
   My bibliography  Save this paper

Income Inequality and Stock Market Returns

Author

Listed:
  • Agnieszka (A.P.) Markiewicz

    (Erasmus University Rotterdam)

  • Rafal Raciborski

    (European Commission)

Abstract

In this paper, we study the relationship between income inequality and stock market returns. We develop a quantitative general equilibrium model that links shifts in both labour and capital income inequality to stock market variables. An increase of the share of capital owners’ income from risky capital leads to higher equity premium and a rise in their non-risky, labor share of income reduces it. When we calibrate our model to match the empirical size of shifts in the last five decades, we find that the negative impact of the higher labour share of income of capital owners dominates and brings the equity premium below the historical value by 0.79 percentage points, in line with the data. If both capital and total income shares of top decile would continue growing at the historical rate between 1970 and 2014, the equity premium would continue decreasing to 6.11% in 2030, 0.92 percentage point lower than historical equity premium of 7.03%. If instead only the capital share of income continues to grow, the equity premium would be higher than the historical average by 0.57 percentage point. If the labour income dispersion remains constant, the historical equity premium of 7.03% would be reached by 2030 if the capital share of income was growing by 1.4% each year.

Suggested Citation

  • Agnieszka (A.P.) Markiewicz & Rafal Raciborski, 2018. "Income Inequality and Stock Market Returns," Tinbergen Institute Discussion Papers 18-075/IV, Tinbergen Institute.
  • Handle: RePEc:tin:wpaper:20180075
    as

    Download full text from publisher

    File URL: https://papers.tinbergen.nl/18075.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Ivo Welch & Amit Goyal, 2008. "A Comprehensive Look at The Empirical Performance of Equity Premium Prediction," Review of Financial Studies, Society for Financial Studies, vol. 21(4), pages 1455-1508, July.
    2. Jason DeBacker & Bradley Heim & Vasia Panousi & Shanthi Ramnath & Ivan Vidangos, 2013. "Rising Inequality: Transitory or Persistent? New Evidence from a Panel of U.S. Tax Returns," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 46(1 (Spring), pages 67-142.
    3. Harald Uhlig, 2007. "Explaining Asset Prices with External Habits and Wage Rigidities in a DSGE Model," American Economic Review, American Economic Association, vol. 97(2), pages 239-243, May.
    4. Òscar Jordà & Moritz Schularick & Alan M. Taylor, 2017. "Macrofinancial History and the New Business Cycle Facts," NBER Macroeconomics Annual, University of Chicago Press, vol. 31(1), pages 213-263.
    5. Anthony B. Atkinson & Thomas Piketty & Emmanuel Saez, 2011. "Top Incomes in the Long Run of History," Journal of Economic Literature, American Economic Association, vol. 49(1), pages 3-71, March.
    6. Kevin J. Lansing & Agnieszka Markiewicz, 2018. "Top Incomes, Rising Inequality and Welfare," Economic Journal, Royal Economic Society, vol. 128(608), pages 262-297, February.
    7. Walentin Karl, 2010. "Earnings Inequality and the Equity Premium," The B.E. Journal of Macroeconomics, De Gruyter, vol. 10(1), pages 1-23, November.
    8. Brent Neiman, 2014. "The Global Decline of the Labor Share," The Quarterly Journal of Economics, Oxford University Press, vol. 129(1), pages 61-103.
    9. Ľluboš Pástor & Robert F. Stambaugh, 2001. "The Equity Premium and Structural Breaks," Journal of Finance, American Finance Association, vol. 56(4), pages 1207-1239, August.
    10. Philippe Weil, 1990. "Nonexpected Utility in Macroeconomics," The Quarterly Journal of Economics, Oxford University Press, vol. 105(1), pages 29-42.
    11. Larry G. Epstein & Stanley E. Zin, 2013. "Substitution, risk aversion and the temporal behavior of consumption and asset returns: A theoretical framework," World Scientific Book Chapters, in: Leonard C MacLean & William T Ziemba (ed.), HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING Part I, chapter 12, pages 207-239, World Scientific Publishing Co. Pte. Ltd..
    12. Favilukis, Jack, 2013. "Inequality, stock market participation, and the equity premium," Journal of Financial Economics, Elsevier, vol. 107(3), pages 740-759.
    13. Fatih Guvenen, 2009. "A Parsimonious Macroeconomic Model for Asset Pricing," Econometrica, Econometric Society, vol. 77(6), pages 1711-1750, November.
    14. Annette Vissing-Jorgensen, 2002. "Limited Asset Market Participation and the Elasticity of Intertemporal Substitution," Journal of Political Economy, University of Chicago Press, vol. 110(4), pages 825-853, August.
    15. James Claus & Jacob Thomas, 2001. "Equity Premia as Low as Three Percent? Evidence from Analysts' Earnings Forecasts for Domestic and International Stock Markets," Journal of Finance, American Finance Association, vol. 56(5), pages 1629-1666, October.
    16. 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.
    17. Fatih Guvenen & Serdar Ozkan & Jae Song, 2014. "The Nature of Countercyclical Income Risk," Journal of Political Economy, University of Chicago Press, vol. 122(3), pages 621-660.
    18. Eichenbaum, Martin & Parker, Jonathan A. (ed.), . "NBER Macroeconomics Annual 2016," National Bureau of Economic Research Books, University of Chicago Press, number 9780226490229, February.
    19. Jermann, Urban J., 1998. "Asset pricing in production economies," Journal of Monetary Economics, Elsevier, vol. 41(2), pages 257-275, April.
    20. Peter Gottschalk & Sheldon Danziger, 2005. "Inequality Of Wage Rates, Earnings And Family Income In The United States, 1975–2002," Review of Income and Wealth, International Association for Research in Income and Wealth, vol. 51(2), pages 231-254, June.
    21. Urban Jermann & Vincenzo Quadrini, 2012. "Macroeconomic Effects of Financial Shocks," American Economic Review, American Economic Association, vol. 102(1), pages 238-271, February.
    22. Epstein, Larry G & Zin, Stanley E, 1991. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: An Empirical Analysis," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 263-286, April.
    23. Lustig, Hanno & Verdelhan, Adrien, 2012. "Business cycle variation in the risk-return trade-off," Journal of Monetary Economics, Elsevier, vol. 59(S), pages 35-49.
    24. Kacperczyk, Marcin & Nosal, Jaromir & Stevens, Luminita, 2019. "Investor sophistication and capital income inequality," Journal of Monetary Economics, Elsevier, vol. 107(C), pages 18-31.
    25. Guiso, Luigi & Sapienza, Paola & Zingales, Luigi, 2018. "Time varying risk aversion," Journal of Financial Economics, Elsevier, vol. 128(3), pages 403-421.
    26. Jonathan A. Schwabish & Julie H. Topoleski, 2013. "Modeling Individual Earnings in CBO’s Long-Term Microsimulation Model: Working Paper 2013-04," Working Papers 44306, Congressional Budget Office.
    27. Edward N. Wolff, 2010. "Recent Trends in Household Wealth in the United States-- Rising Debt and the Middle-Class Squeeze--An Update to 2007," Economics Working Paper Archive wp_589, Levy Economics Institute.
    28. Philippe Weil, 1990. "Non-Expected Utility in Macroeconomics," Post-Print hal-03393362, HAL.
    29. Olivier J. Blanchard, 1993. "Movements in the Equity Premium," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 24(2), pages 75-138.
    30. Davig, Troy, 2004. "Regime-switching debt and taxation," Journal of Monetary Economics, Elsevier, vol. 51(4), pages 837-859, May.
    31. Eichenbaum, Martin & Parker, Jonathan A. (ed.), . "NBER Macroeconomics Annual 2017," National Bureau of Economic Research Books, University of Chicago Press, number 9780226577838, July.
    32. Kevin J. Lansing & Agnieszka Markiewicz, 2018. "Top Incomes, Rising Inequality and Welfare," Economic Journal, Royal Economic Society, vol. 128(608), pages 262-297, February.
    33. Bing Chen & Frank P. Stafford, 2016. "Stock Market Participation: Family Responses to Housing Consumption Commitments," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 48(4), pages 635-659, June.
    34. Kevin J. Lansing, 2015. "Asset Pricing with Concentrated Ownership of Capital and Distribution Shocks," American Economic Journal: Macroeconomics, American Economic Association, vol. 7(4), pages 67-103, October.
    35. Lawrence J. Christiano & Michele Boldrin & Jonas D. M. Fisher, 2001. "Habit Persistence, Asset Returns, and the Business Cycle," American Economic Review, American Economic Association, vol. 91(1), pages 149-166, March.
    36. Urban Jermann & Vincenzo Quadrini, 2012. "Erratum: Macroeconomic Effects of Financial Shocks," American Economic Review, American Economic Association, vol. 102(2), pages 1186-1186, April.
    37. Erik Hurst & Ming Ching Luoh & Frank P. Stafford, 1998. "The Wealth Dynamics of American Families, 1984-94," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(1), pages 267-338.
    38. Emmanuel Saez & Gabriel Zucman, 2016. "Editor's Choice Wealth Inequality in the United States since 1913: Evidence from Capitalized Income Tax Data," The Quarterly Journal of Economics, Oxford University Press, vol. 131(2), pages 519-578.
    39. Jason DeBacker & Bradley Heim & Vasia Panousi & Shanthi Ramnath & Ivan Vidangos, 2013. "Rising Inequality: Transitory or Persistent? New Evidence from a Panel of U.S. Tax Returns," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 44(1 (Spring), pages 67-142.
    40. Fatih Guvenen & Burhanettin Kuruscu, 2006. "Does Market Incompleteness Matter for Asset Prices?," Journal of the European Economic Association, MIT Press, vol. 4(2-3), pages 484-492, 04-05.
    41. Jean-Pierre Danthine & John B. Donaldson, 2002. "Labour Relations and Asset Returns," Review of Economic Studies, Oxford University Press, vol. 69(1), pages 41-64.
    42. Wojciech Kopczuk & Emmanuel Saez & Jae Song, 2010. "Earnings Inequality and Mobility in the United States: Evidence from Social Security Data Since 1937," The Quarterly Journal of Economics, Oxford University Press, vol. 125(1), pages 91-128.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Brett, Craig & Sarkar, Saikat, 2022. "Financial bubbles and income inequality," MPRA Paper 112070, University Library of Munich, Germany.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Martin Andreasen, 2012. "On the Effects of Rare Disasters and Uncertainty Shocks for Risk Premia in Non-Linear DSGE Models," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 15(3), pages 295-316, July.
    2. Favilukis, Jack, 2013. "Inequality, stock market participation, and the equity premium," Journal of Financial Economics, Elsevier, vol. 107(3), pages 740-759.
    3. Kliem, Martin & Uhlig, Harald, 2013. "Bayesian estimation of a DSGE model with asset prices," Discussion Papers 37/2013, Deutsche Bundesbank.
    4. Mohammad R. Jahan-Parvar & Xuan Liu & Philip Rothman, 2013. "Equity Returns and Business Cycles in Small Open Economies," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 45(6), pages 1117-1146, September.
    5. Kuehn Lars-Alexander & Petrosky-Nadeau Nicolas & Zhang Lu, "undated". "An Equilibrium Asset Pricing Model with Labor Market Search," GSIA Working Papers 2010-E63, Carnegie Mellon University, Tepper School of Business.
    6. Liu, Hening & Miao, Jianjun, 2015. "Growth uncertainty, generalized disappointment aversion and production-based asset pricing," Journal of Monetary Economics, Elsevier, vol. 69(C), pages 70-89.
    7. Stijn Claessens & M Ayhan Kose, 2018. "Frontiers of macrofinancial linkages," BIS Papers, Bank for International Settlements, number 95.
    8. Andrew Y. Chen, 2014. "Precautionary Volatility and Asset Prices," Finance and Economics Discussion Series 2014-59, Board of Governors of the Federal Reserve System (U.S.).
    9. Claudio Campanale & Rui Castro & Gian Luca Clementi, 2010. "Asset Pricing in a Production Economy with Chew-Dekel Preferences," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 13(2), pages 379-402, April.
    10. De Graeve, Ferre & Dossche, Maarten & Emiris, Marina & Sneessens, Henri & Wouters, Raf, 2010. "Risk premiums and macroeconomic dynamics in a heterogeneous agent model," Journal of Economic Dynamics and Control, Elsevier, vol. 34(9), pages 1680-1699, September.
    11. Guvenen, Fatih, 2006. "Reconciling conflicting evidence on the elasticity of intertemporal substitution: A macroeconomic perspective," Journal of Monetary Economics, Elsevier, vol. 53(7), pages 1451-1472, October.
    12. Bai, Hang & Zhang, Lu, 2022. "Searching for the equity premium," Journal of Financial Economics, Elsevier, vol. 143(2), pages 897-926.
    13. Felipe S. Iachan & Plamen T. Nenov & Alp Simsek, 2021. "The Choice Channel of Financial Innovation," American Economic Journal: Macroeconomics, American Economic Association, vol. 13(2), pages 333-372, April.
    14. Posch, Olaf, 2011. "Risk premia in general equilibrium," Journal of Economic Dynamics and Control, Elsevier, vol. 35(9), pages 1557-1576, September.
    15. Ludvigson, Sydney C., 2013. "Advances in Consumption-Based Asset Pricing: Empirical Tests," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, volume 2, chapter 0, pages 799-906, Elsevier.
    16. Jerry Tsai & Jessica A. Wachter, 2015. "Disaster Risk and its Implications for Asset Pricing," NBER Working Papers 20926, National Bureau of Economic Research, Inc.
    17. François Gourio, 2013. "Credit Risk and Disaster Risk," American Economic Journal: Macroeconomics, American Economic Association, vol. 5(3), pages 1-34, July.
    18. Francisco Gomes & Alexander Michaelides, 2008. "Asset Pricing with Limited Risk Sharing and Heterogeneous Agents," Review of Financial Studies, Society for Financial Studies, vol. 21(1), pages 415-448, January.
    19. Brand, Claus & Bielecki, Marcin & Penalver, Adrian, 2018. "The natural rate of interest: estimates, drivers, and challenges to monetary policy JEL Classification: E52, E43," Occasional Paper Series 217, European Central Bank.
    20. M. Fatih Guvenen, 2003. "A Parsimonious Macroeconomic Model for Asset Pricing: Habit Formation or Cross-sectional Heterogeneity?," RCER Working Papers 499, University of Rochester - Center for Economic Research (RCER).

    More about this item

    Keywords

    Asset Pricing; Risk Premium Dynamics; Income Inequality; Computational Macroeconomics;
    All these keywords.

    JEL classification:

    • D31 - Microeconomics - - Distribution - - - Personal Income and Wealth Distribution
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • O33 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Technological Change: Choices and Consequences; Diffusion Processes

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:tin:wpaper:20180075. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: . General contact details of provider: https://edirc.repec.org/data/tinbenl.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Tinbergen Office +31 (0)10-4088900 (email available below). General contact details of provider: https://edirc.repec.org/data/tinbenl.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.