Elsevier S & T

Handbook of the Equity Risk Premium

Mehra, Rajnish

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Table of contents

Cover
Contentsvii
List of Contributorsxvii
Prefacexix
Introduction to the Seriesxxiii
Chapter 1. The Equity Premium: ABCs1
1. Introduction2
2. Is the Equity Premium Due to a Premium for Bearing Non-Diversifiable Risk?11
References25
Appendix A29
Appendix B29
Appendix C35
Appendix D35
Chapter 2. Risk-Based Explanations of the Equity Premium37
Introduction39
1. Alternative Preference Structures41
2. Production Economies78
3. Disaster Events and Survivorship Bias81
4. Market Incompleteness and Trading Frictions86
5. Model Uncertainty91
6. Concluding Comments93
References94
Chapter 3. Non-Risk-based Explanations of the Equity Premium101
Introduction102
1. The Inappropriateness of Using T-Bills as a Proxy for the Intertemporal Marginal Rate of Substitu102
2. The Effect of Government Regulations and Rules106
3. Taxes107
4. Borrowing Constraints110
5. The Impact of Agent Heterogeneity and Intermediation Costs113
6. Concluding Comments114
References114
Chapter 4. Equity Premia with Benchmark Levels of Consumption: Closed-Form Results117
1. Preferences120
2. The Canonical Asset126
3. Risk, Term, and Equity Premia131
4. Log-Normality134
5. Risk, Term, and Equity Premia Under Log-Normality with Consumption Externalities and Without Habi135
6. Linear Approximations To Risk, Term, and Equity Premia137
7. Second Moments138
8. Correlation of Dividend-Price Ratio and the Rate of Return on Stock142
9. Special Cases146
10. Accuracy of Approximations153
11. Summary156
References156
Discussion: Equity Premia with Benchmark Levels of Consumption: Closed-Form Results158
1. Introduction158
2. Preferences with Benchmark Levels of Consumption159
3. Changing the Benchmark LevelŽ of the Explanation161
4. Leverage, Correlation Between Dividends and Consumption, and Distorted Beliefs163
5. Final Remarks165
References165
Chapter 5. Long-Run Risks and Risk Compensation in Equity Markets167
1. Introduction168
2. Long-Run Risks Model170
3. Cross-Sectional Implications185
4. Conclusion191
References191
Discussion: Long-Run Risks and Risk Compensation in Equity Markets194
1. Summary194
2. A Low-Frequency Component in Consumption?194
3. Preferences195
4. Returns and Long-Run Cash Flows197
5. Conclusion198
References198
Chapter 6. The Loss Aversion/Narrow Framing Approach to the Equity Premium Puzzle199
1. Introduction201
2. Loss Aversion and Narrow Framing203
3. The Equity Premium207
4. Other Applications224
5. Further Extensions225
6. Conclusion and Future Directions227
References228
Discussion: The Loss Aversion/Narrow Framing Approach to the Equity Premium Puzzle230
1. Work Out More Systematically the Preferences of PT vs. EU Investors„The Equity Protection Puz230
2. Make Quantitative Predictions, Particularly About Equilibrium Market Phenomena, Rather than Just232
3. Do a Version of the Model in Continuous Time233
References234
Discussion: The Loss Aversion/Narrow Framing Approachto the Equity Premium Puzzle235
Reference236
Chapter 7. Financial Markets and the Real Economy237
1. Introduction239
2. Facts: Time Variation and Business Cycle Correlation of Expected Returns244
3. Equity Premium257
4. Consumption Models267
5. Production, Investment, and General Equilibrium290
6. Labor Income and Idiosyncratic Risk302
7. Challenges for the Future314
References314
Appendix322
Discussion: Financial Markets and the Real Economy326
References329
Chapter 8. Understanding the Equity Risk Premium Puzzle331
1. Introduction332
2. Habit Persistence337
3. Limited Stock Market Participation and Per Capita Consumption345
4. Incomplete Markets and Idiosyncratic Income Shocks349
5. Concluding Remarks355
References356
Discussion: Understanding the Equity Risk Premium Puzzle360
1. Introduction360
2. Complete Markets362
3. Missing Markets364
4. Missing Markets and State-Dependent Solvency Constraints370
5. Conclusion372
References372
A. Second-Order Taylor Expansion373
B. Constantinides and Duffie374
Chapter 9. Cash Flow Risk, Discounting Risk, and the Equity Premium Puzzle377
1. Introduction379
2. Economic Determinants of Equity Premium381
3. Time-Series Data on S&P500 EPS, EPS Growth, and the Interest Rate387
4. Implications of the Model for Equity Premium389
5. Concluding Remarks and Extensions396
Appendix398
References400
Discussion: Cash Flow Risk, Discounting Risk, and the Equity Premium Puzzle403
1. Discussion403
References407
Discussion: Cash Flow Risk, Discounting Risk, and the Equity Premium Puzzle409
1. Introduction410
2. The Model410
3. Calibration412
4. Two-Stage Procedure„An Empirical Concern412
5. Conclusion414
References414
Chapter 10. Distribution Risk and Equity Returns415
1. Introduction417
2. The Business Cycle and The Labor Market418
3. The Model Economy423
4. An Economy with Distribution Risk Only430
5. Adding Aggregate Uncertainty432
6. Comparative Dynamics and Welfare Assessment436
7. Technology-Driven Variations in Factor Shares443
8. Robustness446
9. An Alternative Interpretation of the Sharing Mechanism448
10. Related Literature452
11. Concluding Comments459
References460
Discussion: Distribution Risk and Equity Returns463
References466
Chapter 11. The Worldwide Equity Premium: A Smaller Puzzle467
1. Introduction469
2. Prior Estimates of the Equity Premium471
3. Long-Run International Data474
4. Long-Run Historical Rates of Return479
5. New Global Evidence on the Equity Premium486
6. Decomposing the Historical Equity Premium493
7. Conclusion500
References501
Appendix 1: Decomposition of the Equity Premium505
Appendix 2: Data Sources for the DMS Database507
Chapter 12. History and the Equity Risk Premium515
1. Introduction516
2. Historical Conception and Measurement of the Equity Risk Premium517
3. Stocks, Bonds, Bills, and Inflation521
4. History as Written by the Winners?523
5. The Equity Premium Over the Very Long Term524
6. Conclusion527
References528
Discussion: The Worldwide Equity Premium: A Smaller PuzzleŽ and History and the Equity Risk Pre530
References534
Chapter 13. Can Heterogeneity, Undiversified Risk, and Trading Frictions Solve the Equity Premium Pu535
1. Introduction537
2. Labor Income as Background Risk539
3. Entrepreneurial Income as Background Risk552
4. Limited Participation and Limited Diversification555
5. Conclusions556
References556
Discussion: Can Heterogeneity, Undiversified Risk, and Trading Frictions Solve the Equity Premium Pu558
1. Introduction558
2. Labor Income Risk559
3. Transaction Costs560
4. Concentrating Aggregate Risk on Fewer Hands560
5. Conclusion562
References563
Chapter 14. Asset Prices and Intergenerational Risk Sharing: The Role of Idiosyncratic Earnings Shoc565
1. Introduction567
2. An Analytical Example of the Constantinides–Duffie Model569
3. Incorporating the Life Cycle573
4. Quantitative Results577
5. Conclusions581
References584
A. Calibration Appendix587
B. Asset Pricing590
Discussion: Asset Prices and Intergenerational Risk Sharing: The Role of Idiosyncratic Earnings Shoc591
References592
Index593

Book details

Vendor Elsevier S & T
SKU 9780444508997
ISBN-13 9780080555850
Author Mehra, Rajnish
Category Business & Economics
Subject Banks & Banking

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Edited by Rajnish Mehra, this volume focuses on the equity risk premium puzzle, a term coined by Mehra and Prescott in 1985 which encompasses a number of empirical regularities in the prices of capital assets that are at odds with the predictions of standard economic theory.

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