A new methodology for studying the equity premium

This paper provides a new framework for the derivation and estimation of consumption and the equity premium functions. The novelty in our approach is that it does not require the explicit specification of the underlying consumer preferences. Applying duality in a dynamic context, we derive simple explicit expressions for both consumption and equity premium. We show that equity premium and consumption functions can be easily obtained by "Roy's Identity like" equations from the indirect utility function. Using aggregate US data (1929-2000) we estimate the consumption and equity premium functions using a nonparametric technique. We find that the model does well in explaining the observed smooth consumption patterns and does reasonably well in explaining the high mean and volatility of equity premia.

• Type: Journal
• Year: 2010
• Where: ANOR
• Authors: Elie Appelbaum, Parantap Basu
• Keywords: ANOR 2010, Equity Premium, Equity Premium Functions, Simple Explicit Expressions