The structural break in the equity premium

Chang-Jin Kim, James C. Morley, Charles R. Nelson

Research output: Contribution to journalArticle

34 Citations (Scopus)

Abstract

This article uses Bayesian marginal likelihood analysis to compare univariate models of the stock return behavior and test for structural breaks in the equity premium. The analysis favors a model that relates the equity premium to Markov-switching changes in the level of market volatility and accommodates volatility feedback. For this model, there is evidence of a one-time structural break in the equity premium in the 1940s, with no evidence of additional breaks in the postwar period. The break in the 1940s corresponds to a permanent reduction in the general level of stock market volatility. Meanwhile, there appears to be no change in the underlying risk preferences relating the equity premium to market volatility. The estimated unconditional equity premium drops from an annualized 12% before to the break to 9% after the break.

Original languageEnglish
Pages (from-to)181-191
Number of pages11
JournalJournal of Business and Economic Statistics
Volume23
Issue number2
DOIs
Publication statusPublished - 2005 Apr 1

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Structural Breaks
Equity
premium
equity
Volatility
Markov Switching
Marginal Likelihood
Stock Returns
post-war period
market
stock market
Stock Market
Univariate
evidence
Equity premium
Structural breaks
Model

Keywords

  • Bayes factor
  • Equity premium
  • Marginal likelihood
  • Markov switching
  • Structural break
  • Volatility feedback

ASJC Scopus subject areas

  • Statistics and Probability
  • Economics and Econometrics
  • Social Sciences (miscellaneous)
  • Statistics, Probability and Uncertainty

Cite this

The structural break in the equity premium. / Kim, Chang-Jin; Morley, James C.; Nelson, Charles R.

In: Journal of Business and Economic Statistics, Vol. 23, No. 2, 01.04.2005, p. 181-191.

Research output: Contribution to journalArticle

Kim, Chang-Jin ; Morley, James C. ; Nelson, Charles R. / The structural break in the equity premium. In: Journal of Business and Economic Statistics. 2005 ; Vol. 23, No. 2. pp. 181-191.
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