The author investigates the link between aggregate risk and the asset returns in a dynamic production based asset-pricing model. When calibrated to match asset return moments, the model implies that the post-1984 reduction in TFP shock volatility of 60 percent gives rise to a 40 percent decline in the equity premium. Lower macroeconomic risk post-1984 can account for a substantial fraction of the decline in the equity premium.
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Macroeconomic Volatility and the Equity Premium
December 2005
WP 06-01 – Recent empirical work documents a decline in the U.S. equity premium and a decline in the standard deviation of real output growth.
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