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The equity premium and inflation

The equity premium and inflation

Abstract

This empirical study examines the relation between the equity premium - the difference between the expected stock and risk-free return - and inflation in the major economies in the post-Bretton Woods era. We estimate a country-average level of the equity premium between 0.8% and 2%, confirming a shrinking premium. Regressions and impulse responses show that the equity premium significantly positively adjusts to inflation. Inflation is thus essential in explaining the level of the equity premium and provides a partial resolution to the equity premium puzzle.
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