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Searching for the Equity Premium

Author

Listed:
  • Bai, Hang

    (U of Connecticut)

  • Zhang, Lu

    (Ohio State U)

Abstract

Labor market frictions are crucial for the equity premium in production economies. A dynamic stochastic general equilibrium model with recursive utility, search frictions, and capital accumulation yields a high equity premium of 4.26% per annum, a stock market volatility of 11.8%, and a low average interest rate of 1.59%, while simultaneously retaining plausible business cycle dynamics. The equity premium and stock market volatility are strongly countercyclical, while the interest rate and consumption growth are largely unpredictable. Because of wage inertia, dividends are procyclical despite consumption smoothing via capital investment. The welfare cost of business cycles is huge, 29%.

Suggested Citation

  • Bai, Hang & Zhang, Lu, 2020. "Searching for the Equity Premium," Working Paper Series 2020-23, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    • Handle: RePEc:ecl:ohidic:2020-23
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    Cited by:

    1. Mahlstedt, Robert & Weber, Rüdiger, 2020. "Risk Sharing Within and Outside the Firm: The Disparate Effects of Wrongful Discharge Laws on Expected Stock Returns," IZA Discussion Papers 13941, Institute of Labor Economics (IZA).

    More about this item

    JEL classification:

    • 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
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • J23 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Labor Demand

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