A new methodology for studying the equity premium |
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Authors: | Elie Appelbaum Parantap Basu |
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Institution: | 1. Department of Economics, York University, 4700 Keele street, Toronto, ON, M3J 1P3, Canada 2. Durham University, Durham, UK
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Abstract: | This paper provides a new framework for the derivation and estimation of consumption and equity premium functions. Applying duality in a dynamic context, we show that equity premium and consumption functions can be easily obtained from the indirect utility function. Our new framework, therefore, does not require explicit specification of underlying consumer preferences. 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. |
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