The Equity Premium and Structural Breaks


  • Ľluboš Pástor,

  • Robert F. Stambaugh

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    • Graduate School of Business, University of Chicago (Pástor) and the Wharton School, University of Pennsylvania and the National Bureau of Economic Research (Stambaugh). Stambaugh acknowledges support provided by his appointment during the 1997 to 1998 academic year as a Marvin Bower Fellow at Harvard Business School, where portions of this research were conducted. Pástor is grateful for research support from the Center for Research in Security Prices and Dimensional Fund Advisors. Comments from Kent Daniel, René Stulz, Walt Torous, Zhenyu Wang, and seminar participants at the University of Chicago, the 1999 Western Finance Association Meetings, the 1999 UCLA Equity Premium Conference, and the 2001 American Finance Association Meetings are appreciated.


A long return history is useful in estimating the current equity premium even if the historical distribution has experienced structural breaks. The long series helps not only if the timing of breaks is uncertain but also if one believes that large shifts in the premium are unlikely or that the premium is associated, in part, with volatility. Our framework incorporates these features along with a belief that prices are likely to move opposite to contemporaneous shifts in the premium. The estimated premium since 1834 fluctuates between 4 and 6 percent and exhibits its sharpest drop in the last decade.