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Title: The determinants of UK Equity Risk Premium
Author: Chandorkar, Pankaj Avinash
ISNI:       0000 0004 6349 9339
Awarding Body: Cranfield University
Current Institution: Cranfield University
Date of Award: 2016
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Equity Risk Premium (ERP) is the cornerstone in Financial Economics. It is a basic requirement in stock valuation, evaluation of portfolio performance and asset allocation. For the last decades, several studies have attempted to investigate the relationship between macroeconomic drivers of ERP. In this work, I empirically investigate the macroeconomic determinants of UK ERP. For this I parsimoniously cover a large body of literature stemming from ERP puzzle. I motivate the empirical investigation based on three mutually exclusive theoretical lenses. The thesis is organised in the journal paper format. In the first paper I review the literature on ERP over the past twenty-eight years. In particular, the aim of the paper is three fold. First, to review the methods and techniques, proposed by the literature to estimate ERP. Second, to review the literature that attempts to resolve the ERP puzzle, first coined by Mehra and Prescott (1985), by exploring five different types of modifications to the standard utility framework. And third, to review the literature that investigates and develops relationship between ERP and various macroeconomic and market factors in domestic and international context. I find that ERP puzzle is still a puzzle, within the universe of standard power utility framework and Consumption Capital Asset Pricing Model, a conclusion which is in line with Kocherlakota (1996) and Mehra (2003). In the second paper, I investigate the impact of structural monetary policy shocks on ex-post ERP. More specifically, the aim of this paper is to investigate the whether the response of UK ERP is different to the structural monetary policy shocks, before and after the implementation of Quantitative Easing in the UK. I find that monetary policy shocks negatively affect the ERP at aggregate level. However, at the sectoral level, the magnitude of the response is heterogeneous. Further, monetary policy shocks have a significant negative (positive) impact on the ERP before (after) the implementation of Quantitative Easing (QE). The empirical evidence provided in the paper sheds light on the equity market’s asymmetric response to the Bank of England’s monetary policy before and after the monetary stimulus. In the third paper I examine the impact of aggregate and disaggregate consumption shocks on the ex-post ERP of various FTSE indices and the 25 Fama-French style value-weighted portfolios, constructed on the basis of size and book-to-market characteristics. I extract consumption shocks using Structural Vector Autoregression (SVAR) and investigate its time-series and cross-sectional implications for ERP in the UK. These structural consumption shocks represent deviation of agent’s actual consumption path from its theoretically expected path. Aggregate consumption shocks seem to explain significant time variation in the ERP. At disaggregated level, when the actual consumption is less than expected, the ERP rises. Durable and Semi-durable consumption shocks have a greater impact on the ERP than non-durable consumption shocks. In the fourth and final paper I investigate the impact of short and long term market implied volatility on the UK ERP. I also examine the pricing implications of innovations to short and long term implied market volatility in the cross-section of stocks returns. I find that both the short and the long term implied volatility have significant negative impact on the aggregate ERP, while at sectoral level the impact is heterogeneous. I find both short and long term volatility is priced negatively indicating that (i) investors care both short and long term market implied volatility (ii) investors are ready to pay for insurance against these risks.
Supervisor: Poshakwale, Sunil Sponsor: Not available
Qualification Name: Thesis (Ph.D.) Qualification Level: Doctoral
EThOS ID:  DOI: Not available
Keywords: Structural VAR ; Consumption-CAPM ; Monetary Policy ; Stock Returns ; Implied Volatility ; Quantitative Easing ; Bank of England ; interest rate shocks ; dis-aggregated consumption