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Maximum Likelihood Estimation of the Equity Premium

69 Pages Posted: 30 May 2014 Last revised: 4 Oct 2016

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)

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Date Written: September 12, 2016

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 more reliable estimates under a wide range of specifications.

 

Suggested Citation

Avdis, Efstathios and Wachter, Jessica A., Maximum Likelihood Estimation of the Equity Premium (September 12, 2016). The Wharton School Research Paper No. 57. Available at SSRN: https://ssrn.com/abstract=2443529

Efstathios Avdis (Contact Author)

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

2-32C Business Building
Edmonton, Alberta T6G 2R6
Canada

Jessica A. Wachter

University of Pennsylvania - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States
215-898-7634 (Phone)
215-898-6200 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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