Estimating the Equity Premium

R. Glen Donaldson, Mark Kamstra () and Lisa Kramer

Journal of Financial and Quantitative Analysis, 2010, vol. 45, issue 4, 813-846

Abstract: Existing empirical research investigating the size of the equity premium has largely consisted of a series of innovations around a common theme: producing a better estimate of the equity premium by using better data or a better estimation technique. The equity premium estimate that emerges from most of this work matches one moment of the data alone: the mean difference between an estimate of the return to holding equity and a risk-free rate. We instead match multiple moments of U.S. market data, exploiting the joint distribution of the dividend yield, return volatility, and realized excess returns, and find that the equity premium lies within 50 basis points of 3.5%, a range much narrower than was achieved in previous studies. Additionally, statistical tests based on the joint distribution of these moments reveal that only those models of the conditional equity premium that embed time variation, breaks, and/or trends are supported by the data. In order to develop the joint distribution of the dividend yield, return volatility, and excess returns, we need a model of price and return fundamentals. We document that even recently developed analytically tractable models that permit autocorrelated dividend growth rates and discount rates impose restrictions that are rejected by the data. We therefore turn to a wider range of models, requiring numerical solution methods and parameter estimation by the simulated method of moments.

Date: 2010
References: Add references at CitEc
Citations: View citations in EconPapers (6)

Downloads: (external link)
https://www.cambridge.org/core/product/identifier/ ... type/journal_article link to article abstract page (text/html)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cup:jfinqa:v:45:y:2010:i:04:p:813-846_00

Access Statistics for this article

More articles in Journal of Financial and Quantitative Analysis from Cambridge University Press Cambridge University Press, UPH, Shaftesbury Road, Cambridge CB2 8BS UK.
Bibliographic data for series maintained by Kirk Stebbing ().