Working Paper

Macroeconomic volatility and the equity premium

Abstract: Recent empirical work documents a decline in the U.S. equity premium and a decline in the standard deviation of real output growth. We investigate the link between aggregate risk and the asset returns in a dynamic production based asset-pricing model. When calibrated to match asset return moments, the model implies that the post-1984 reduction in TFP shock volatility of 60 percent gives rise to a 40 percent decline in the equity premium. Lower macroeconomic risk post-1984 can account for a substantial fraction of the decline in the equity premium.

Keywords: Equity; Macroeconomics;

Bibliographic Information

Provider: Federal Reserve Bank of Philadelphia

Part of Series: Working Papers

Publication Date: 2006

Number: 06-1