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Elucidating Equity Premium Using Corporate Dividends And Habit Formation

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  • JOW-RAN CHANG

    (Department of Quantitative Finance, National Tsing Hua University, 101, Sec. 2, Kuang-Fu Rd., Hsinchu, Taiwan)

  • HSU-HSIEN CHU

    (#x2020;Institute of Technology Science Management, National Tsing Hua University, 101, Sec. 2, Kuang-Fu Rd., Hsinchu, Taiwan)

Abstract

This paper extends Longstaff and Piazzesi (2004, Journal of Financial Economics, 74, 401–421.) to a habit formation model. By combining corporate fraction ratio, and surplus consumption ratio, we derive closed-form solutions for stock values when dividends, habit ratio and consumption follow exponential affine jump-diffusion processes. We can prove that Longstaff and Piazzesi (2004) is only a special case of our model. In addition, calibrated results show that the corporate fraction and habit ratio to shocks significantly increases the equity premium and decreases the risk-free rate. The model determines realistic values for the equity premium and the risk-free rate.

Suggested Citation

  • Jow-Ran Chang & Hsu-Hsien Chu, 2015. "Elucidating Equity Premium Using Corporate Dividends And Habit Formation," Annals of Financial Economics (AFE), World Scientific Publishing Co. Pte. Ltd., vol. 10(02), pages 1-20, December.
    • Handle: RePEc:wsi:afexxx:v:10:y:2015:i:02:n:s2010495215500141
    DOI: 10.1142/S2010495215500141
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    References listed on IDEAS

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