Premium
The Equity Premium: Consistent with GDP Growth and Portfolio Insurance
Author(s) -
Faugère Christophe,
Van Erlach Julian
Publication year - 2006
Publication title -
financial review
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.621
H-Index - 47
eISSN - 1540-6288
pISSN - 0732-8516
DOI - 10.1111/j.1540-6288.2006.00156.x
Subject(s) - economics , equity premium puzzle , value premium , equity ratio , liquidity premium , monetary economics , equity (law) , financial economics , portfolio , dividend , growth stock , equity risk , econometrics , stock market , risk premium , capital asset pricing model , market liquidity , finance , private equity , restricted stock , paleontology , horse , biology , law , liquidity crisis , political science
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.