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The Equity Premium: Consistent with GDP Growth and Portfolio Insurance

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  • Christophe Faugère
  • Julian Van Erlach

Abstract

We find that the long‐term equity premium is consistent with both GDP growth and portfolio insurance. We use a supply‐side growth model and demonstrate that the arithmetic average stock market return and the returns on corporate assets and debt depend on GDP per capita growth. The implied equity premium matches the U.S. historical average over 1926–2001. Separately, we find that the equity premium tracks the value of a put option on the S&P 500. Our theory predicts a smaller equity premium in the future, assuming that the recent regime shifts in dividend policies, interest rates, and tax rates are permanent.

Suggested Citation

  • Christophe Faugère & Julian Van Erlach, 2006. "The Equity Premium: Consistent with GDP Growth and Portfolio Insurance," The Financial Review, Eastern Finance Association, vol. 41(4), pages 547-564, November.
    • Handle: RePEc:bla:finrev:v:41:y:2006:i:4:p:547-564
    DOI: 10.1111/j.1540-6288.2006.00156.x
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    Cited by:

    1. Gregorio Impavido & Esperanza Lasagabaster & Manuel Garcia-Huitron, 2010. "New Policies for Mandatory Defined Contribution Pensions : Industrial Organization Models and Investment Products," World Bank Publications - Books, The World Bank Group, number 2462.
    2. Gregorio Impavido & Esperanza Lasagabaster & Manuel Garcia-Huitron, 2010. "New Policies for Mandatory Defined Contribution Pensions : Industrial Organization Models and Investment Products," World Bank Publications, The World Bank, number 2462, September.
    3. repec:idb:brikps:365 is not listed on IDEAS
    4. Kimberly D. Zieschang, 2016. "FISIM Accounting," CEPA Working Papers Series WP012016, School of Economics, University of Queensland, Australia.
    5. Christophe Faugere & Julian Van Erlach, 2003. "A General Theory of Stock Market Valuation and Return," Finance 0311005, University Library of Munich, Germany, revised 17 May 2004.
    6. Elie Appelbaum & Parantap Basu, 2010. "A new methodology for studying the equity premium," Annals of Operations Research, Springer, vol. 176(1), pages 109-126, April.
    7. Christophe, Faugere, 2003. "A Required Yield Theory of Stock Market Valuation and Treasury Yield Determination," MPRA Paper 15579, University Library of Munich, Germany, revised 04 Jun 2009.
    8. Cohen, Ruben D, 2009. "Constructing a GDP-based Index for Use as Benchmark," MPRA Paper 18390, University Library of Munich, Germany.
    9. Blake, David & Cairns, Andrew & Dowd, Kevin, 2008. "Turning pension plans into pension planes: What investment strategy designers of defined contribution pension plans can learn from commercial aircraft designers," MPRA Paper 33749, University Library of Munich, Germany.

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