Explaining Equity Risk Premium during Financial Crises
25 Pages Posted: 22 Aug 2013 Last revised: 31 Aug 2013
Date Written: August 20, 2013
This paper investigates the dynamics among three non-equity factors, credit, illiquidity, and foreign exchange risks, and equity returns to explore the equity risk premium. Results from both VAR and EGARCHM models demonstrate that credit and liquidity risk premia and changes in exchange rates explain equity returns in Germany, Japan, the United Kingdom, and the United States during recent financial crises. More importantly, the traditional measure of the equity market risk premium ceases to be significant in explaining equity returns when these three non-equity factors are included in the model. Although its explaining power is significant in the US, its significant level is lower. Our results offer convincing evidence that these three non-equity factors explain the equity risk premium during financial crises.
Keywords: LIBOR-OIS Spread, CDS, USDX, Exchange Rates, Equity Risk Premia
JEL Classification: E51, F31, G12
Suggested Citation: Suggested Citation