Understanding Risk and Return
53 Pages Posted: 14 Aug 2007
Date Written: November 1993
This paper uses an intertemporal equilibrium asset pricing model to interpret the cross-sectional pattern of stock and bond returns. The model relates assets' mean returns to their covariances with the contemporaneous return and news about future returns on the market portfolio. In a departure from standard practice, the market portfolio return is measured using data on both the aggregate stock market and aggregate labor income. The paper finds that aggregate stock market risk is the main factor determining excess stock and bond returns, but that the price of stock market risk does not equal the coefficient of relative risk aversion as would be implied by the static Capital Asset Pricing Model.
Suggested Citation: Suggested Citation