Risk and Return: An Equilibrium Approach

Abstract

This paper develops a regime switching, pure exchange economy which duplicates many of the empirical features of the relation between the expectation and volatility of stock returns. The key features of the model are heteroscedasticity in inflation, regimes which mimic the expansionary and contractionary phases of the economy, and transitions between regimes which depend on the level of inflation. These features result in time-varying and asymmetric cross serial correlations between the conditional moments of returns.