The Equity Premium and the One Percent

Toda, Alexis Akira and Walsh, Kieran James (2014): The Equity Premium and the One Percent.

Abstract

We show that in a general equilibrium model with heterogeneity in risk aversion or belief, shifting wealth from an agent who holds comparatively fewer stocks to one who holds more reduces the equity premium. Since empirically the rich hold more stocks than do the poor, the top income share should predict subsequent excess stock market returns. Consistent with our theory, we find that when the income share of top earners in the U.S. rises, subsequent one year excess market returns significantly decline. This negative relation is robust to (i) controlling for classic return predictors such as the price-dividend and consumption-wealth ratios, (ii) predicting out-of-sample, and (iii) instrumenting with changes in estate tax rates. Cross-country panel regressions suggest that the inverse relation between inequality and returns also holds outside of the U.S., with stronger results in relatively closed economies (emerging markets) than in small open economies (Europe).

• Item Type: MPRA Paper
• Language: English
• Keywords: equity premium, heterogeneous risk aversion, return prediction, wealth distribution, international equity markets
• Subjects: D - Microeconomics > D3 - Distribution > D31 - Personal Income, Wealth, and Their Distributions; D - Microeconomics > D5 - General Equilibrium and Disequilibrium > D52 - Incomplete Markets; D - Microeconomics > D5 - General Equilibrium and Disequilibrium > D53 - Financial Markets; F - International Economics > F3 - International Finance > F30 - General; G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates; G - Financial Economics > G1 - General Financial Markets > G17 - Financial Forecasting and Simulation

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