The Return to Capital and the Business Cycle

FRB of Cleveland Working Paper No. 06-03

34 Pages Posted: 24 Mar 2006

See all articles by Paul Gomme

Paul Gomme

Concordia University; CIREQ

B. Ravikumar

Federal Reserve Bank of Saint Louis

Peter Rupert

University of California, Santa Barbara (UCSB) - Department of Economics

Date Written: February 2006

Abstract

Real business cycle models have difficulty replicating the volatility of S&P 500 returns. This fact should not be surprising since real business cycle theory suggests that the return to capital should be measured by the return to aggregate market capital, not stock market returns. We construct a quarterly time series of the after-tax return to business capital. Its volatility is considerably smaller than that of S&P 500 returns. The standard business cycle model captures almost 40% of the volatility in the return to capital (relative to the volatility of output). We consider several departures from the benchmark model; the most promising is one with higher risk aversion which captures over 60% of the relative volatility in the return to capital.

Keywords: return to capital, returns volatility, measurement

JEL Classification: G12, E32

Suggested Citation

Gomme, Paul and Ravikumar, B. and Rupert, Peter, The Return to Capital and the Business Cycle (February 2006). FRB of Cleveland Working Paper No. 06-03. Available at SSRN: https://ssrn.com/abstract=890353 or http://dx.doi.org/10.2139/ssrn.890353

Paul Gomme (Contact Author)

Concordia University ( email )

1455 de Maisonneuve Blvd. W.
Montreal, Quebec H3G 1MB
Canada

CIREQ ( email )

C.P. 6128, Succursale Centre-ville
Montreal, Quebec H3C 3J7
Canada

B. Ravikumar

Federal Reserve Bank of Saint Louis ( email )

411 Locust St
Saint Louis, MO 63011
United States

Peter Rupert

University of California, Santa Barbara (UCSB) - Department of Economics ( email )

2127 North Hall
Santa Barbara, CA 93106
United States

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