Macroeconomic Models of the Equity Premium

Paper Session

Friday, Jan. 6, 2017 2:30 PM – 4:30 PM

Sheraton Grand Chicago, Sheraton Ballroom II
Hosted By: American Finance Association
  • Chair: Sydney Ludvigson, New York University

Macro Announcement Premium and Risk Preferences

Hengjie Ai
University of Minnesota
Ravi Bansal
Duke University


Empirical evidence shows that a large fraction of equity premium is realized on a relatively small number of trading days with significant macroeconomic news announcements. In the 1961-2014 period, for example, about 55% of the entire equity premium is earned on about 30 trading days per year with significant macroeconomic announcements. In addition, the market equity premium typically rises prior to the announcement and falls immediately afterwards. In this paper, we develop an abstract theory and a quantitative model for the equity premium associated with macroeconomic news announcements. We demonstrate that the announcement premium identifies the compensation for investors' uncertainty aversion on capital markets. We present a dynamic model to account for the evolution of equity premium around macroeconomic announcements.

Dividend Dynamics, Learning, and Expected Stock Index Returns

Ravi Jagannathan
Northwestern University
Binying Liu
Northwestern University


We show that, in a frictionless and ecient market, an asset pricing model that
better describes investors' behavior should better forecast stock index returns. We
propose a dividend model that predicts, out-of-sample, 31.3% of the variation in
annual dividend growth rates (1976-2015). Further, when learning about dividend
dynamics is incorporated into a long-run risks model, the model predicts, out-ofsample,
22.4% of the variation in annual stock index returns (1976-2015). This
supports the view that both investors' aversion to long-run risks and learning about
these risks are important in determining asset prices and expected returns.

The Equity Premium and the One Percent

Alexis Akira Toda
University of California-San Diego
Kieran James Walsh
University of Virginia


We show that in a general equilibrium model with heterogeneity in risk aversion or belief, shifting wealth from an agent who holds comparatively fewer stocks to one who holds more reduces the equity premium. Since empirically the rich hold more stocks than do the poor, the top income share should predict subsequent excess stock market returns. Consistent with our theory, we find that when the income share of top earners in the U.S. rises, subsequent one year market excess returns significantly decline. This negative relation is robust to (i) controlling for classic return predictors such as the price-dividend and consumption-wealth ratios, (ii) predicting out-of-sample, and (iii) instrumenting with changes in estate tax rates. Cross-country panel regressions suggest that the inverse relation between inequality and returns also holds outside of the U.S., with stronger results in relatively closed economies (emerging markets) than in small open economies (Europe).

Maximum Likelihood Estimation of the Equity Premium

Efstathios Avdis
University of Alberta
Jessica Wachter
University of Pennsylvania


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 esti- mator, based on maximum likelihood, that takes into account informa- tion 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.
Anisha Ghosh
Carnegie Mellon University
Lars Lochstoer
Columbia University
Daniel Greenwald
Massachusetts Institute of Technology
Ralph Koijen
London Business School
JEL Classifications
  • G1 - General Financial Markets