A new methodology for studying the equity premium

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 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.