Maximum Likelihood Estimation of the Equity Premium

68 Pages Posted: 28 Nov 2013 Last revised: 15 Apr 2023

See all articles by Efstathios Avdis

Efstathios Avdis

University of Alberta - Department of Finance and Statistical Analysis

Jessica A. Wachter

University of Pennsylvania - Finance Department; National Bureau of Economic Research (NBER); Securities and Exchange Commission

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Date Written: November 2013

Abstract

The equity premium, namely the expected return on the aggregate stock market less the government bill rate, is of central importance to the portfolio allocation of individuals, to the investment decisions of firms, and to model calibration and testing. This quantity is usually estimated from the sample average excess return. We propose an alternative estimator, based on maximum likelihood, that takes into account information contained in dividends and prices. Applied to the postwar sample, our method leads to an economically significant reduction from 6.4% to 5.1%. Simulation results show that our method produces tighter estimates under a range of specifications.

Suggested Citation

Avdis, Efstathios and Wachter, Jessica A., Maximum Likelihood Estimation of the Equity Premium (November 2013). NBER Working Paper No. w19684, Available at SSRN: https://ssrn.com/abstract=2360952

Efstathios Avdis (Contact Author)

University of Alberta - Department of Finance and Statistical Analysis ( email )

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Edmonton, Alberta T6G 2R6
Canada

Jessica A. Wachter

University of Pennsylvania - Finance Department ( email )

The Wharton School
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Philadelphia, PA 19104
United States
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215-898-6200 (Fax)

National Bureau of Economic Research (NBER)

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Securities and Exchange Commission ( email )

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