The Equity Risk Premium: A Review of Models

American Economic Review

Gourinchas

2017

The secular decline in safe interest rates since the early 1980s has been the subject of considerable attention. In this short paper, we argue that it is important to consider the evolution of safe real rates in conjunction with three other first-order macroeconomic stylized facts: the relative constancy of the real return to productive capital, the decline in the labor share, and the decline and subsequent stabilization of the earnings yield. Through the lens of a simple accounting framework, these four facts offer suggestive insights into the economic forces that might be at work.

Section: Four Facts and A Frameworkmentioning

confidence: 99%

“…Figure 1 panel D from Duarte and Rosa (2015) reports the first principal component estimated across 20 models of the ERP , using different 5 Estimates of the debt to assets or debt to capital ratios have been relatively stable between 40 and 50 percent since 1990. See Graham, Leary, and Roberts (2014).…”

Section: Four Facts and A Frameworkmentioning

confidence: 99%

Rents, Technical Change, and Risk Premia Accounting for Secular Trends in Interest Rates, Returns on Capital, Earning Yields, and Factor Shares

American Economic Review

Gourinchas

2017

“…First, Figure 9 reports the one-year U.S. Treasury yield, together with the expected risk premium (ERP) from Duarte and Rosa (2015). The ERP is constructed as the first principal component of twenty models of the one-year ahead U.S. equity risk premium.…”

Section: Safe Assets and Risk Premiamentioning

confidence: 99%

Global Imbalances and Policy Wars at the Zero Lower Bound

Gourinchas

2015

This paper explores the consequences of extremely low equilibrium real interest rates in a world with integrated but heterogenous capital markets and nominal rigidities. In this context, we establish five main results: (i) Economies experiencing liquidity traps pull others into a similar situation by running current account surpluses; (ii) Reserve currencies have a tendency to bear a disproportionate share of the global liquidity trap|a phenomenon we dub the "reserve currency paradox"; (iii) While more price and wage flexibility exacerbates the risk of a deflationary global liquidity trap, it is the more rigid economies that bear the brunt of the recession; (iv) Beggar-thyneighbor exchange rate devaluations provide stimulus to the undertaking country at the expense of other countries (zero-sum); and (v) Safe public debt issuances, helicopter drops of money, and increases in government spending in any country are expansionary for all countries (positivesum). We use these results to shed light on the evolution of global imbalances, interest rates, and exchange rates since the beginning of the global financial crisis.

“…The stark divergence between safe and risky expected One-year Treasury yield One year ahead ERP Financial Crisis Figure 1: Short-term interest rates (one-year Treasury yield), equity risk premium (one-year ahead equity risk premium or ERP), and expected return on equity (sum of one-year ahead Treasury yield and of one-year ahead ERP). Sources: one-year Treasury yield: Federal Reserve H.15; one year ahead ERP: Duarte and Rosa (2015). The ERP is calculated as the first principal component of twenty models of the one-year-ahead equity risk premium.…”

Section: Introductionmentioning

confidence: 99%

The Safety Trap

The Review of Economic Studies

2017

In this paper we provide a model of the macroeconomic implications of safe asset shortages. In particular, we discuss the emergence of a deflationary safety trap equilibrium with high risk premia. It is an acute form of a liquidity trap, in which the shortage of a specific form of assets, safe assets, as opposed to a general shortage of assets, is the fundamental driving force. At the zero lower bound (ZLB), our model has a Keynesian cross representation, in which net safe asset supply plays the role of an aggregate demand shifter. Essentially, safety traps correspond to liquidity traps in which the emergence of an endogenous risk premium significantly alters the connection between macroeconomic policy and economic activity. "Helicopter drops" of money, safe public debt issuances, swaps of private risky assets for safe public debt, or increases in the inflation target, stimulate aggregate demand and output, while forward guidance is less effective. The safety trap can be arbitrarily persistent, as in the secular stagnation hypothesis, despite the existence of infinitely lived assets.