The Equity Premium and the Business Cycle: The Role of Demand and Supply Shocks

34 Pages Posted: 7 Apr 2009

See all articles by Peter N. Smith

Peter N. Smith

University of York - Department of Economics and Related Studies; Australian National University (ANU) - Centre for Applied Macroeconomic Analysis (CAMA)

Steffen Sorensen

Moody's Investor Services

Michael Wickens

University of Cardiff; Centre for Economic Policy Research (CEPR); Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute)

Date Written: March 2009

Abstract

This paper explores the effects of the US business cycle on US stock market returns through an analysis of the equity risk premium. We propose a new methodology based on the SDF approach to asset pricing that allows us to uncover the different effects of aggregate demand and supply shocks. We find that negative shocks are more important that positive shocks, and that supply shocks have a much greater impact than demand shocks.

Keywords: business cycles, demand and supply shocks, equity premium, stock returns

JEL Classification: C32, C51, E44, G12

Suggested Citation

Smith, Peter N. and Sorensen, Steffen and Wickens, Michael, The Equity Premium and the Business Cycle: The Role of Demand and Supply Shocks (March 2009). CEPR Discussion Paper No. DP7227. Available at SSRN: https://ssrn.com/abstract=1372547

Peter N. Smith

University of York - Department of Economics and Related Studies ( email )

Heslington
York 010 5DD
United Kingdom
+44 1904 433 765 (Phone)
+44 1904 433 759 (Fax)

Australian National University (ANU) - Centre for Applied Macroeconomic Analysis (CAMA) ( email )

ANU College of Business and Economics
Canberra, Australian Capital Territory 0200
Australia

Steffen Sorensen

Moody's Investor Services

New York, NY 10007
United States

Michael Wickens (Contact Author)

University of Cardiff; Centre for Economic Policy Research (CEPR) ( email )

Centre for Economic Policy Research (CEPR)

London
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

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