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A Note on the McGrattan and Prescott (2003) Adjustments and the Equity Premium Puzzle

  • Selahattin Imrohoroglu

    (USC)

McGrattan and Prescott (2003) argue that the average equity premium is less than one percent when the annual data used in the computation are adjusted in certain ways: equity returns reduced by subtracting diversification costs and taxes on dividend yields, and debt yields are raised by using long-term debt (instead of 90-day T-Bills) and ignoring the 1935-1960 period of government regulation of the financial sector. This note takes the adjusted measurements proposed by McGrattan and Prescott (2003) and subjects them to statistical tests in an attempt to examine the equity premium puzzle. The findings suggest that using their series solves the `average equity premium' puzzle but the `low risk-free rate' and `excess volatility' puzzles remain as challenges to standard theory.

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File URL: http://econwpa.repec.org/eps/mac/papers/0402/0402009.pdf
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Paper provided by EconWPA in its series Macroeconomics with number 0402009.

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Length: 12 pages
Date of creation: 04 Feb 2004
Date of revision:
Handle: RePEc:wpa:wuwpma:0402009
Note: Type of Document - pdf; prepared on Win2000; pages: 12
Contact details of provider: Web page: http://econwpa.repec.org

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  1. Campbell, John Y., 2003. "Consumption-based asset pricing," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 13, pages 803-887 Elsevier.
  2. Lars Peter Hansen & Ravi Jagannathan, 1990. "Implications of security market data for models of dynamic economies," Discussion Paper / Institute for Empirical Macroeconomics 29, Federal Reserve Bank of Minneapolis.
  3. John Y. Campbell & John H. Cochrane, 1994. "By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," CRSP working papers 412, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  4. Robert J. Shiller, 1982. "Consumption, Asset Markets, and Macroeconomic Fluctuations," NBER Working Papers 0838, National Bureau of Economic Research, Inc.
  5. Ellen R. McGrattan & Edward C. Prescott, 2003. "Average Debt and Equity Returns: Puzzling?," American Economic Review, American Economic Association, vol. 93(2), pages 392-397, May.
  6. Constantinides,George & Duffie,Darrel, 1992. "Asset pricing with heterogeneous consumers," Discussion Paper Serie A 381, University of Bonn, Germany.
  7. Abel, Andrew B, 1990. "Asset Prices under Habit Formation and Catching Up with the Joneses," American Economic Review, American Economic Association, vol. 80(2), pages 38-42, May.
  8. 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.
  9. Hansen, Lars Peter & Singleton, Kenneth J, 1982. "Generalized Instrumental Variables Estimation of Nonlinear Rational Expectations Models," Econometrica, Econometric Society, vol. 50(5), pages 1269-86, September.
  10. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
  11. 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.
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