The Equity Premium: Consistent with GDP Growth and Portfolio Insurance
Posted: 13 Aug 2006
We find that the long-term equity premium is consistent with both GDP growth and portfolio insurance. We use a supply-side growth model and demonstrate that the arithmetic average stock market return and the returns on corporate assets and debt depend on GDP per capita growth. The implied equity premium matches the U.S. historical average over 1926-2001. Separately, we find that the equity premium tracks the value of a put option on the S&P 500. Our theory predicts a smaller equity premium in the future, assuming the recent regime shifts in dividend policies, interest rates, and tax rates are permanent.
Keywords: Equity Premium, GDP Growth, T-Bills, Downside Risk, Portfolio Insurance
JEL Classification: G10, G12
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