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136
Risks for the long run: A potential resolution of asset pricing puzzles
 JOURNAL OF FINANCE
, 1994
"... We model consumption and dividend growth rates as containing (i) a small longrun predictable component and (ii) fluctuating economic uncertainty (consumption volatility). These dynamics, for which we provide empirical support, in conjunction with Epstein and Zin’s (1989) preferences, can explain ke ..."
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Cited by 348 (30 self)
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We model consumption and dividend growth rates as containing (i) a small longrun predictable component and (ii) fluctuating economic uncertainty (consumption volatility). These dynamics, for which we provide empirical support, in conjunction with Epstein and Zin’s (1989) preferences, can explain key asset markets phenomena. In our economy, financial markets dislike economic uncertainty and better longrun growth prospects raise equity prices. The model can justify the equity premium, the riskfree rate, and the volatility of the market return, riskfree rate, and the pricedividend ratio. As in the data, dividend yields predict returns and the volatility of returns is timevarying.
Resurrecting the (C)CAPM: A CrossSectional Test When Risk Premia Are TimeVarying
 Journal of Political Economy
, 2001
"... This paper explores the ability of conditional versions of the CAPM and the consumption CAPM—jointly the (C)CAPM—to explain the cross section of average stock returns. Central to our approach is the use of the log consumption–wealth ratio as a conditioning variable. We demonstrate that such conditio ..."
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Cited by 137 (4 self)
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This paper explores the ability of conditional versions of the CAPM and the consumption CAPM—jointly the (C)CAPM—to explain the cross section of average stock returns. Central to our approach is the use of the log consumption–wealth ratio as a conditioning variable. We demonstrate that such conditional models perform far better than unconditional specifications and about as well as the FamaFrench threefactor model on portfolios sorted by size and booktomarket characteristics. The conditional consumption CAPM can account for the difference in returns between lowbooktomarket and highbooktomarket portfolios and exhibits little evidence of residual size or booktomarket effects. We are grateful to Eugene Fama and Kenneth French for graciously providing the
Asset pricing at the millennium
 Journal of Finance
"... This paper surveys the field of asset pricing. The emphasis is on the interplay between theory and empirical work and on the tradeoff between risk and return. Modern research seeks to understand the behavior of the stochastic discount factor ~SDF! that prices all assets in the economy. The behavior ..."
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Cited by 123 (3 self)
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This paper surveys the field of asset pricing. The emphasis is on the interplay between theory and empirical work and on the tradeoff between risk and return. Modern research seeks to understand the behavior of the stochastic discount factor ~SDF! that prices all assets in the economy. The behavior of the term structure of real interest rates restricts the conditional mean of the SDF, whereas patterns of risk premia restrict its conditional volatility and factor structure. Stylized facts about interest rates, aggregate stock prices, and crosssectional patterns in stock returns have stimulated new research on optimal portfolio choice, intertemporal equilibrium models, and behavioral finance. This paper surveys the field of asset pricing. The emphasis is on the interplay between theory and empirical work. Theorists develop models with testable predictions; empirical researchers document “puzzles”—stylized facts that fail to fit established theories—and this stimulates the development of new theories. Such a process is part of the normal development of any science. Asset pricing, like the rest of economics, faces the special challenge that data are generated naturally rather than experimentally, and so researchers cannot control the quantity of data or the random shocks that affect the data. A particularly interesting characteristic of the asset pricing field is that these random shocks are also the subject matter of the theory. As Campbell, Lo, and MacKinlay ~1997, Chap. 1, p. 3! put it: What distinguishes financial economics is the central role that uncertainty plays in both financial theory and its empirical implementation. The starting point for every financial model is the uncertainty facing investors, and the substance of every financial model involves the impact of uncertainty on the behavior of investors and, ultimately, on mar* Department of Economics, Harvard University, Cambridge, Massachusetts
A Comprehensive Look at the Empirical Performance of Equity Premium Prediction,” working paper
, 2004
"... Given the historically high equity premium, is it now a good time to invest in the stock market? Economists have suggested a whole range of variables that investors could or should use to predict: dividend price ratios, dividend yields, earningsprice ratios, dividend payout ratios, net issuing rati ..."
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Cited by 121 (4 self)
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Given the historically high equity premium, is it now a good time to invest in the stock market? Economists have suggested a whole range of variables that investors could or should use to predict: dividend price ratios, dividend yields, earningsprice ratios, dividend payout ratios, net issuing ratios, bookmarket ratios, interest rates (in various guises), and consumptionbased macroeconomic ratios (cay). The typical paper reports that the variable predicted well in an insample regression, implying forecasting ability. Our paper explores the outofsample performance of these variables, and finds that not a single one would have helped a realworld investor outpredicting the thenprevailing historical equity premium mean. Most would have outright hurt. Therefore, we find that, for all practical purposes, the equity premium has not been predictable, and any belief about whether the stock market is now too high or too low has to be based on theoretical prior, not on the empirically variables we have explored.
Forecasting output and inflation: The role of asset prices
 Journal of Economic Literature
, 2003
"... Because asset prices are forwardlooking, they constitute a class of potentially useful predictors of inflation and output growth. The premise that interest rates and asset ..."
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Cited by 118 (1 self)
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Because asset prices are forwardlooking, they constitute a class of potentially useful predictors of inflation and output growth. The premise that interest rates and asset
The Equity Premium
 Journal of Finance
, 2002
"... We estimate the equity premium using dividend and earnings growth rates to measure the expected rate of capital gain. Our estimates for 1951 to 2000, 2.55 percent and 4.32 percent, are much lower than the equity premium produced by the average stock return, 7.43 percent. Our evidence suggests that t ..."
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Cited by 108 (3 self)
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We estimate the equity premium using dividend and earnings growth rates to measure the expected rate of capital gain. Our estimates for 1951 to 2000, 2.55 percent and 4.32 percent, are much lower than the equity premium produced by the average stock return, 7.43 percent. Our evidence suggests that the high average return for 1951 to 2000 is due to a decline in discount rates that produces a large unexpected capital gain. Our main conclusion is that the average stock return of the last halfcentury is a lot higher than expected.
Investor Sentiment and the CrossSection of Stock Returns
, 2003
"... We examine how investor sentiment affects the crosssection of stock returns. Theory predicts that a broad wave of sentiment will disproportionately affect stocks whose valuations are highly subjective and are difficult to arbitrage. We test this prediction by studying how the crosssection of subse ..."
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Cited by 100 (8 self)
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We examine how investor sentiment affects the crosssection of stock returns. Theory predicts that a broad wave of sentiment will disproportionately affect stocks whose valuations are highly subjective and are difficult to arbitrage. We test this prediction by studying how the crosssection of subsequent stock returns varies with proxies for beginningofperiod investor sentiment. When sentiment is low, subsequent returns are relatively high on smaller stocks, high volatility stocks, unprofitable stocks, nondividendpaying stocks, extremegrowth stocks, and distressed stocks, consistent with an initial underpricing of these stocks. When sentiment is high, on the other hand, these patterns attenuate or fully reverse. The results are consistent with predictions and appear unlikely to reflect an alternative explanation based on compensation for systematic risk.
Stock Return Predictability and Model Uncertainty
, 2002
"... We use Bayesian model averaging to analyze the sample evidence on return predictability in the presence of model uncertainty. The analysis reveals insample and outofsample predictability, and shows that the outofsample performance of the Bayesian approach is superior to that of model selecti ..."
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Cited by 96 (3 self)
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We use Bayesian model averaging to analyze the sample evidence on return predictability in the presence of model uncertainty. The analysis reveals insample and outofsample predictability, and shows that the outofsample performance of the Bayesian approach is superior to that of model selection criteria. We find that term and market premia are robust predictors. Moreover, smallcap value stocks appear more predictable than largecap growth stocks. We also investigate the implications of model uncertainty from investment management perspectives. We show that model uncertainty is more important than estimation risk, and investors who discard model uncertainty face large utility losses.
Understanding Predictability
 JOURNAL OF POITICAL ECONOMY
, 2004
"... We propose a general equilibrium model with multiple securities in which investors’ risk preferences and expectations of dividend growth are time varying. While time varying risk preferences induce the standard positive relation between the dividend yield and expected returns, time varying expected ..."
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Cited by 86 (4 self)
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We propose a general equilibrium model with multiple securities in which investors’ risk preferences and expectations of dividend growth are time varying. While time varying risk preferences induce the standard positive relation between the dividend yield and expected returns, time varying expected dividend growth induces a negative relation between them. These offsetting effects reduce the ability of the dividend yield to forecast returns and eliminate its ability to forecast dividend growth, as observed in the data. The model links the predictability of returns to that of dividend growth, suggesting specific changes to standard linear predictive regressions for both. The model’s predictions are con…rmed empirically.
A ConsumptionBased Model of the Term Structure of Interest Rates
, 2004
"... This paper proposes a consumptionbased model that can account for many features of the nominal term structure of interest rates. The driving force behind the model is a timevarying price of risk generated by external habit. Nominal bonds depend on past consumption growth through habit and on expec ..."
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Cited by 70 (4 self)
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This paper proposes a consumptionbased model that can account for many features of the nominal term structure of interest rates. The driving force behind the model is a timevarying price of risk generated by external habit. Nominal bonds depend on past consumption growth through habit and on expected inflation. When calibrated to data on consumption, inflation, and the average level of bond yields, the model produces realistic volatility of bond yields and can explain key aspects of the expectations puzzle documented by Campbell and Shiller (1991) and Fama and Bliss (1987). When actual consumption and inflation data are fed into the model, the model is shown to account for many of the short and longrun fluctuations in the shortterm interest rate and the yield spread. At the same time, the model captures the high equity premium and