Working Paper: NBER ID: w7778
Authors: Lubos Pastor; Robert F. Stambaugh
Abstract: A long return history is useful in estimating the current equity premium even if the historical distribution has experienced structural breaks. The long series helps not only if the timing of breaks is uncertain but also if one believes that large shifts in the premium are unlikely or that the premium is associated, in part, with volatility. Our framework incorporates these features along with a belief that prices are likely to move opposite to contemporaneous shifts in the premium. The estimated premium since 1834 fluctuates between four and six percent and exhibits its sharpest drop in the last decade.
Keywords: Equity Premium; Structural Breaks; Volatility; Bayesian Inference
JEL Codes: G12; C11
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| equity premium (G12) | volatility (E32) |
| historical return data (N22) | equity premium (G12) |
| structural breaks (L16) | uncertainty in equity premium estimation (D81) |
| equity premium (G12) | price changes (P22) |
| prior beliefs about premium-volatility link (C58) | equity premium (G12) |