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The Equity Premium: Consistent with GDP Growth and Portfolio Insurance

27 Pages Posted: 3 Dec 2003  

Christophe Faugère

Kedge Business School Bordeaux

Julian Van Erlach

Nexxus Wealth Technologies, Inc.

Multiple version iconThere are 3 versions of this paper

Date Written: September 2006

Abstract

The long-term equity premium value is found to both be consistent with historic gross domestic product (GDP) growth and portfolio insurance against downside risk. First, we use a supply-side growth model and demonstrate that the arithmetic average stock market return and the returns on corporate assets and debt all depend on GDP/capita growth. The implied equity premium matches the U.S. historical average over 1926-2001. Alternately, an option-based approach shows that the equity premium is closely approximated by the premium of a put option for insuring a $1 real investment in the stock market against downside risk on a year-to-year basis. A smaller equity premium is predicted by our theory, assuming the recent regime shifts in dividend policies, interest rates, and tax rates are permanent.

Keywords: Equity Premium, GDP Growth, Corporate Debt, T-Bills, Risk-Free Rate, Downside Risk, Options, Protective Puts, Portfolio Insurance, Total Stock Return

JEL Classification: G10, G12

Suggested Citation

Faugère, Christophe and Van Erlach, Julian, The Equity Premium: Consistent with GDP Growth and Portfolio Insurance (September 2006). Available at SSRN: https://ssrn.com/abstract=465321 or http://dx.doi.org/10.2139/ssrn.465321

Christophe Faugère (Contact Author)

Kedge Business School Bordeaux ( email )

680 Cours de la Liberation
Bordeaux, Aquitaine 33405
France

Julian Van Erlach

Nexxus Wealth Technologies, Inc. ( email )

1508 Nelson Dr.
Irving, TX 75038
United States
651-558-6242 (Phone)

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