Between 1926 and 1970, the equity premium calculated this way averaged 6.8 percentage points for publicly traded stocks. Since 1970, however, the premium has averaged 0.7 of a percentage point, just about zero. Jagannathan, McGrattan, and Scherbina demonstrate that the dramatic decline they find is robust to a variety of assumptions and consistent with the results of other recent studies. They compare the value of U.S. corporate equity to the value of U.S. corporations productive assets. Here productive assets include both tangible and intangible assets, as well as assets used outside the country by subsidiaries of U.S. corporations.
Intangible assets present a particularly difficult measurement problem.
But McGrattan and Prescott devise an innovative and persuasive way to estimate the value of all these assets. The study concludes that the stock market is today correctly valuing capital. The two studies in this issue do not, of course, guarantee that asset values and returns won t change drastically in the near future. Any views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System.