Abstract
This paper provides new estimates and tests of a number of leading general equilibrium theories of the price of equity and, to our knowledge, the first estimates of the time-varying equity premia implied by these models. Three general equilibrium theories are examined: the consumption-CAPM with power utility, the Epstein-Zin general equilibrium model with time non-separable preferences and habit-persistence models. We compare these models with the more restrictive unconditional CAPM, and with more general models based on discount factors which encompass all of these models. Rather than use GMM estimation or calibration, we propose a new model, the multi-variate GARCH—covariance-in-mean (MGCM) model that is constrained to satisfy a no-arbitrage condition by including conditional covariance terms in the mean of the asset-pricing equation. This enables us to estimate time-varying risk premia and to investigate the contribution to the risk premium of macroeconomic sources of equity risk. In particular, we examine the role of inflation in pricing the nominal equity risk premium and show that it has importance beyond that implied by the canonical models. Estimates are obtained for monthly data from 1975-2001 for the US and UK stock markets.
| Original language | English |
|---|---|
| Pages (from-to) | 35-66 |
| Number of pages | 32 |
| Journal | Quantitative and Qualitative Analysis in Social Sciences |
| Volume | 3 |
| Issue number | n/a |
| Publication status | Published - 2008 |