The Equity Risk Premium, Market Factors, and the Maturing Economy Hypothesis

Abstract

Researchers have attributed the significant decline in the volatility of realGDP growth among maturing nations over the last thirty years to a decrease in theinfluence of destabilizing factors. It is hypothesized that many of the same macro factorshave had a similar decreasing impact on the long-run equity risk premium (ERP) as theU.S. economy has matured. A model developed by Perron (1989) and Perron andVogelsang (1992) is used to identify a 1954 break in the ERP. ARCH and GARCHeffects found in the 1870-2002 ERP disappear in pre and post break estimates of themodel as do the significance of macro variables. The results lend partial support to thehypothesis that broad market factors such as money supply, productivity and populationchange imparted greater influence on the ERP during the first half of the 20th century.(N20, G12)