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The Equity Premium: Consistent with GDP Growth and Portfolio Insurance

Christophe Faugere () and Julian Van Erlach

The Financial Review, 2006, vol. 41, issue 4, 547-564

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.

Date: 2006
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Handle: RePEc:bla:finrev:v:41:y:2006:i:4:p:547-564