Finance Papers

Document Type

Journal Article

Date of this Version

6-2013

Publication Source

The Journal of Finance

Volume

68

Issue

3

Start Page

987

Last Page

1035

DOI

10.1111/jofi.12018

Abstract

Why is the equity premium so high, and why are stocks so volatile? Why are stock returns in excess of government bill rates predictable? This paper proposes an answer to these questions based on a time-varying probability of a consumption disaster. In the model, aggregate consumption follows a normal distribution with low volatility most of the time, but with some probability of a consumption realization far out in the left tail. The possibility of this poor outcome substantially increases the equity premium, while time-variation in the probability of this outcome drives high stock market volatility and excess return predictability.

Copyright/Permission Statement

This is the peer reviewed version of the following article, which has been published in final form at http://dx.doi.org/10.1111/jofi.12018. This article may be used for non-commercial purposes in accordance with Wiley Terms and Conditions for Self-Archiving.

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Date Posted: 27 November 2017

This document has been peer reviewed.