Searching for the equity premium

Hang Bai and Lu Zhang

Journal of Financial Economics, 2022, vol. 143, issue 2, 897-926

Abstract: A dynamic stochastic general equilibrium model with recursive utility, search frictions, and capital accumulation is a good start to forming a unified theory of asset prices and business cycles. The model reproduces an equity premium of 4.27% per annum, a stock market volatility of 12.42%, and an average interest rate of 1.97%, while retaining plausible business cycle dynamics. The equity premium and stock market volatility are strongly countercyclical, whereas the interest rate and consumption growth are largely unpredictable. Because of wage inertia, dividends are procyclical despite consumption smoothing via investment. The welfare cost of business cycles is huge, 33.6%.

Keywords: The equity premium puzzle; Macro finance; DSGE; Search frictions; Wage inertia (search for similar items in EconPapers)
JEL-codes: E32 E44 G12 G14 J23 J64 (search for similar items in EconPapers)
Date: 2022
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:143:y:2022:i:2:p:897-926

DOI: 10.1016/j.jfineco.2021.05.024

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