Searching for the Equity Premium

Hang Bai and Lu Zhang
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Hang Bai: U of Connecticut
Lu Zhang: Ohio State U

Working Paper Series from Ohio State University, Charles A. Dice Center for Research in Financial Economics

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%.

JEL-codes: E32 E44 G12 J23 (search for similar items in EconPapers)
Date: 2020-10
New Economics Papers: this item is included in nep-dge, nep-mac and nep-upt
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:ecl:ohidic:2020-23

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