Working Paper: CEPR ID: DP7227
Authors: Peter N. Smith; Steffen Sorensen; Michael R. Wickens
Abstract: This paper explores the effects of the US business cycle on US stock market returns through an analysis of the equity risk premium. We propose a new methodology based on the SDF approach to asset pricing that allows us to uncover the different effects of aggregate demand and supply shocks. We find that negative shocks are more important that positive shocks, and that supply shocks have a much greater impact than demand shocks.
Keywords: business cycles; demand and supply shocks; equity premium; stock returns
JEL Codes: C32; C51; E44; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| negative aggregate supply shocks (E00) | increased risk premium (G19) |
| negative demand shocks (E31) | increased risk premium (G19) |
| positive demand shocks (E00) | decreased risk premium (G19) |
| positive supply shocks (E65) | minimal negative impact on equity premium (G40) |
| supply shocks (E39) | increased risk premium during recessions (E44) |
| negative shocks (F69) | more significant impact on stock returns (G17) |
| conditional covariance between inflation and output (E31) | effects of supply shocks during recessions (E65) |