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Understanding Risk and Return

  • John Y. Campbell

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.

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Paper provided by Harvard - Institute of Economic Research in its series Harvard Institute of Economic Research Working Papers with number 1711.

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Date of creation: 1995
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Handle: RePEc:fth:harver:1711
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Web page: http://www.economics.harvard.edu/journals/hier

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  1. Lo, Andrew W & MacKinlay, A Craig, 1990. "Data-Snooping Biases in Tests of Financial Asset Pricing Models," Review of Financial Studies, Society for Financial Studies, vol. 3(3), pages 431-67.
  2. Craig A. MacKinlay, . "Multifactor Models Do Not Explain Deviations From the CAPM (Revised: 21-94)," Rodney L. White Center for Financial Research Working Papers 15-93, Wharton School Rodney L. White Center for Financial Research.
  3. Epstein, Larry G & Zin, Stanley E, 1989. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework," Econometrica, Econometric Society, vol. 57(4), pages 937-69, July.
  4. Fama, Eugene F. & Schwert, G. William, 1977. "Human capital and capital market equilibrium," Journal of Financial Economics, Elsevier, vol. 4(1), pages 95-125, January.
  5. Fama, Eugene F, 1970. "Multiperiod Consumption-Investment Decisions," American Economic Review, American Economic Association, vol. 60(1), pages 163-74, March.
  6. Chen, Nai-Fu, 1991. " Financial Investment Opportunities and the Macroeconomy," Journal of Finance, American Finance Association, vol. 46(2), pages 529-54, June.
  7. James M. Poterba & Lawrence H. Summers, 1987. "Mean Reversion in Stock Prices: Evidence and Implications," NBER Working Papers 2343, National Bureau of Economic Research, Inc.
  8. Lawrence H. Summers, 1982. "Tax Policy, the Rate of Return, and Savings," NBER Working Papers 0995, National Bureau of Economic Research, Inc.
  9. Campbell, John Y, 1991. "A Variance Decomposition for Stock Returns," Economic Journal, Royal Economic Society, vol. 101(405), pages 157-79, March.
  10. S. Grossman & R. Shiller, . "The Determinants of the Variability of Stock Market Price," Rodney L. White Center for Financial Research Working Papers 18-80, Wharton School Rodney L. White Center for Financial Research.
  11. Fama, Eugene F. & French, Kenneth R., 1988. "Dividend yields and expected stock returns," Journal of Financial Economics, Elsevier, vol. 22(1), pages 3-25, October.
  12. Arturo Estrella & Gikas A. Hardouvelis, 1989. "The term structure as a predictor of real economic activity," Research Paper 8907, Federal Reserve Bank of New York.
  13. Hansen, Lars Peter & Singleton, Kenneth J, 1982. "Generalized Instrumental Variables Estimation of Nonlinear Rational Expectations Models," Econometrica, Econometric Society, vol. 50(5), pages 1269-86, September.
  14. Fama, Eugene F & French, Kenneth R, 1992. " The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-65, June.
  15. John Y. Campbell, 1992. "Intertemporal Asset Pricing Without Consumption Data," NBER Working Papers 3989, National Bureau of Economic Research, Inc.
  16. Jorion, Philippe & Giovannini, Alberto, 1993. "Time-series tests of a non-expected-utility model of asset pricing," European Economic Review, Elsevier, vol. 37(5), pages 1083-1100, June.
  17. Hansen, Lars Peter & Singleton, Kenneth J, 1983. "Stochastic Consumption, Risk Aversion, and the Temporal Behavior of Asset Returns," Journal of Political Economy, University of Chicago Press, vol. 91(2), pages 249-65, April.
  18. Campbell, J.Y. & Shiller, R.J., 1988. "Stock Prices, Earnings And Expected Dividends," Papers 334, Princeton, Department of Economics - Econometric Research Program.
  19. Chen, Nai-Fu & Roll, Richard & Ross, Stephen A, 1986. "Economic Forces and the Stock Market," The Journal of Business, University of Chicago Press, vol. 59(3), pages 383-403, July.
  20. Alberto Giovannini & Philippe Weil, 1989. "Risk Aversion and Intertemporal Substitution in the Capital Asset Pricing Model," NBER Working Papers 2824, National Bureau of Economic Research, Inc.
  21. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-54, July.
  22. Gikas A. Hardouvelis & Dongcheol Kim & Thierry A. Wizman, 1992. "Intertemporal asset pricing models and the cross section of expected stock returns," Research Paper 9218, Federal Reserve Bank of New York.
  23. Keim, Donald B. & Stambaugh, Robert F., 1986. "Predicting returns in the stock and bond markets," Journal of Financial Economics, Elsevier, vol. 17(2), pages 357-390, December.
  24. Ferson, Wayne E & Harvey, Campbell R, 1991. "The Variation of Economic Risk Premiums," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 385-415, April.
  25. Kandel, Shmuel & Stambaugh, Robert F., 1991. "Asset returns and intertemporal preferences," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 39-71, February.
  26. Fama, Eugene F & French, Kenneth R, 1988. "Permanent and Temporary Components of Stock Prices," Journal of Political Economy, University of Chicago Press, vol. 96(2), pages 246-73, April.
  27. Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-87, September.
  28. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
  29. Hall, Alastair R., 2004. "Generalized Method of Moments," OUP Catalogue, Oxford University Press, number 9780198775201, March.
  30. Grossman, S J & Melino, Angelo & Shiller, Robert J, 1987. "Estimating the Continuous-Time Consumption-Based Asset-Pricing Model," Journal of Business & Economic Statistics, American Statistical Association, vol. 5(3), pages 315-27, July.
  31. Fama, Eugene F. & French, Kenneth R., 1989. "Business conditions and expected returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 25(1), pages 23-49, November.
  32. John Y. Campbell, 1985. "Stock Returns and the Term Structure," NBER Working Papers 1626, National Bureau of Economic Research, Inc.
  33. repec:fth:harver:1421 is not listed on IDEAS
  34. Roll, Richard, 1977. "A critique of the asset pricing theory's tests Part I: On past and potential testability of the theory," Journal of Financial Economics, Elsevier, vol. 4(2), pages 129-176, March.
  35. Friend, Irwin & Blume, Marshall E, 1975. "The Demand for Risky Assets," American Economic Review, American Economic Association, vol. 65(5), pages 900-922, December.
  36. Ross, Stephen A., 1976. "The arbitrage theory of capital asset pricing," Journal of Economic Theory, Elsevier, vol. 13(3), pages 341-360, December.
  37. Fama, Eugene F. & Schwert, G. William, 1977. "Asset returns and inflation," Journal of Financial Economics, Elsevier, vol. 5(2), pages 115-146, November.
  38. Harvey, Campbell R., 1989. "Time-varying conditional covariances in tests of asset pricing models," Journal of Financial Economics, Elsevier, vol. 24(2), pages 289-317.
  39. Epstein, Larry G & Zin, Stanley E, 1991. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: An Empirical Analysis," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 263-86, April.
  40. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
  41. Chan, K. C. & Chen, Nai-fu & Hsieh, David A., 1985. "An exploratory investigation of the firm size effect," Journal of Financial Economics, Elsevier, vol. 14(3), pages 451-471, September.
  42. Roll, Richard & Ross, Stephen A, 1980. " An Empirical Investigation of the Arbitrage Pricing Theory," Journal of Finance, American Finance Association, vol. 35(5), pages 1073-1103, December.
  43. Sims, Christopher A, 1980. "Macroeconomics and Reality," Econometrica, Econometric Society, vol. 48(1), pages 1-48, January.
  44. Black, Fischer, 1990. "Mean Reversion and Consumption Smoothing," Review of Financial Studies, Society for Financial Studies, vol. 3(1), pages 107-14.
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