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612
AN EQUILIBRIUM CHARACTERIZATION OF THE TERM STRUCTURE
, 1977
"... The paper derives a general form of the term structure of interest rates. The following assumptions are made: (A.l) The instantaneous (spot) interest rate follows a diffusion process; (A.2) the price of a discount bond depends only on the spot rate over its term; and (A.3) the market is efficient. U ..."
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Cited by 603 (0 self)
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The paper derives a general form of the term structure of interest rates. The following assumptions are made: (A.l) The instantaneous (spot) interest rate follows a diffusion process; (A.2) the price of a discount bond depends only on the spot rate over its term; and (A.3) the market is efficient. Under these assumptions, it is shown by means of an arbitrage argument that the expected rate of return on any bond in excess of the spot rate is proportional to its standard deviation. This property is then used to derive a partial differential equation for bond prices. The solution to that equation is given in the form of a stochastic integral representation. An interpretation of the bond pricing formula is provided. The model is illustrated on a specific case.
On estimating the expected return on the market  an exploratory investigation
 Journal of Financial Economics
, 1980
"... The expected market return is a number frequently required for the solution of many investment and corporate tinance problems, but by comparison with other tinancial variables, there has been little research on estimating this expected return. Current practice for estimating the expected market retu ..."
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Cited by 245 (1 self)
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The expected market return is a number frequently required for the solution of many investment and corporate tinance problems, but by comparison with other tinancial variables, there has been little research on estimating this expected return. Current practice for estimating the expected market return adds the historical average realized excess market returns to the current observed interest rate. While this model explicitly reflects the dependence of the market return on the interest rate, it fails to account for the effect of changes in the level of market risk. Three models of equilibrium expected market returns which reflect this dependence are analyzed in this paper. Estimation procedures which incorporate the prior restriction that equilibrium expected excess returns on the market must be positive are derived and applied to return data for the period 19261978. The principal conclusions from this exploratory investigation are: (1) in estimating models of the expected market return, the nonnegativity restriction of the expected excess return should be explicitly included as part of the specification; (2) estimators which use realized returns should be adjusted for heteroscedasticity. 1.
Labor supply flexibility and portfolio choice, Working paper no. 3043 (National Bureau of Economic Research
, 1989
"... This paper examines the effect of the laborleisure choice on portfolio and consumption decisions over an individual’s life cycle. The model incorporates the fact that individuals may have considerable flexibility in varying their work effort (including their choice of when to retire). Given this fl ..."
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Cited by 193 (8 self)
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This paper examines the effect of the laborleisure choice on portfolio and consumption decisions over an individual’s life cycle. The model incorporates the fact that individuals may have considerable flexibility in varying their work effort (including their choice of when to retire). Given this flexibility, the individual simultaneously determines optimal levels of current consumption, labor effort, and an optimal financial investment strategy at each point in his life cycle. We show that labor and investment choices are intimately related. The ability to vary labor supply ex post induces the individual to assume greater risks in his investment portfolio ex ante. 1.
Portfolio Choice and Asset Prices; The Importance of Entrepreneurial Risk
, 1999
"... this paper with an empirical investigation into some of the risk factors and demographic variables that might explain these crosssectional differences in portfolio composition. A number of previous studies have focused on the level and variability of wage income growth as one of the largest sources ..."
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Cited by 178 (7 self)
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this paper with an empirical investigation into some of the risk factors and demographic variables that might explain these crosssectional differences in portfolio composition. A number of previous studies have focused on the level and variability of wage income growth as one of the largest sources of undiversifiable income risk. Here we present evidence that, for the subset of the population that has significant stock holdings, income from entrepreneurial ventures (which we refer to as proprietary business income) represents a large source of undiversifiable risk that is more highly correlated with common stock returns. These findings motivate the investigation in the second part of the paper of a linear asset pricing model that incorporates proprietary income from privately held businesses as a risk factor.
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
Consumption and portfolio choice over the life cycle, Working paper
, 1998
"... This paper solves a realistically calibrated lifecycle model of consumption and portfolio choice with uninsurable labor income risk and borrowing constraints. Since labor income substitutes for riskless asset holdings the optimal share invested in equities is roughly decreasing over life. We comput ..."
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Cited by 118 (12 self)
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This paper solves a realistically calibrated lifecycle model of consumption and portfolio choice with uninsurable labor income risk and borrowing constraints. Since labor income substitutes for riskless asset holdings the optimal share invested in equities is roughly decreasing over life. We compute a measure of the importance of nontradable human capital for investment behavior to find that ignoring labor income generates large utility costs, while the cost of ignoring only its risk is an order of magnitude smaller. We also quantify the utility cost associated with typical heuristics advocated by financial advisors. The issue of portfolio choice over the lifecycle is encountered by every investor. Popular finance books (e.g. Malkiel, 1996) and financial counselors generally give the advice to shift the portfolio composition towards relatively safe assets, such as Tbills, and away from risky stocks as the investor grows older and reaches retirement. But what could be the economic
The Asymptotic Elasticity of Utility Functions and Optimal Investment in Incomplete Markets
 Annals of Applied Probability
, 1997
"... . The paper studies the problem of maximizing the expected utility of terminal wealth in the framework of a general incomplete semimartingale model of a financial market. We show that the necessary and sufficient condition on a utility function for the validity of several key assertions of the theor ..."
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Cited by 110 (9 self)
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. The paper studies the problem of maximizing the expected utility of terminal wealth in the framework of a general incomplete semimartingale model of a financial market. We show that the necessary and sufficient condition on a utility function for the validity of several key assertions of the theory to hold true is the requirement that the asymptotic elasticity of the utility function is strictly less then one. 1. Introduction A basic problem of mathematical finance is the problem of an economic agent, who invests in a financial market so as to maximize the expected utility of his terminal wealth. In the framework of a continuoustime model the problem was studied for the first time by R. Merton in two seminal papers [27] and [28] (see also [29] as well as [32] for a treatment of the discrete time case). Using the methods of stochastic optimal control Merton derived a nonlinear partial differential equation (Bellman equation) for the value function of the optimization problem. He al...
Intertemporally dependent preferences and the volatility of consumption and wealth
 Review of Financial Studies
, 1989
"... In this article we construct a model in which a consumer’s utility depends on the consumption history We describe a general equilibrium framework similar to Cox, Ingersoll, and Ross (1985a). A simple example is then solved in closedform in this general equilibrium setting to rationalize the observed ..."
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Cited by 107 (2 self)
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In this article we construct a model in which a consumer’s utility depends on the consumption history We describe a general equilibrium framework similar to Cox, Ingersoll, and Ross (1985a). A simple example is then solved in closedform in this general equilibrium setting to rationalize the observed stickiness of the consumption series relative to the fluctuations in stock market wealth. The sample paths of consumption generated from this model imply lower variability in consumption growth rates compared to those generated by models with separable utilizations. We then present a partial equilibrium model similar to Merton (1969, 1971) and extend Merton’s results on optimal consumption and portfolio rules to accommodate nonseparability in preferences. Asset pricing implications of our framework are briefly explored. The idea that a given bundle of consumption goods will provide the same level of satisfaction at any date regardless of one’s past consumption experience is implicit in models that use timeseparable utility functions to represent preferences. Separable utility functions have been the mainstay in much of the literature on asset pricing and optimal consumption and portfolio The results reported in this article were first presented at the EFA meetings in Bern, Switzerland, in 1985 [see Sundaresan (1984)]. Subsequently the article was presented at a number of universities and conferences. I thank the participants at those presentations for their feedback. I am especially thankful to Doug Breeden, Michael Brennan, John Cox, Chifu Huang, and Krishna Ramaswamy for their thoughtful comments and criticisms. I also thank Tongsheng Sun for explaining the simulation procedure for stochastic differential equations and for his comments and suggestions. I am responsible for any remaining errors. Correspondence should be sent to Suresh M. Sundaresan, Graduate
International Asset Allocation with Regime Shifts, Review of Financial Studies, forthcoming
 Business Cycles in International Historical Perspective, Journal of Economic Perspectives
, 2002
"... especially grateful for the thoughtful and thorough comments of the referee which greatly improved the paper. Geert Bekaert thanks the NSF for financial support. ..."
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Cited by 100 (4 self)
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especially grateful for the thoughtful and thorough comments of the referee which greatly improved the paper. Geert Bekaert thanks the NSF for financial support.
Portfolio selection in stochastic environments, Working Paper
 Review of Financial Studies
, 1999
"... In this article, I explicitly solve dynamic portfolio choice problems, up to the solution of an ordinary differential equation (ODE), when the asset returns are quadratic and the agent has a constant relative risk aversion (CRRA) coefficient. My solution includes as special cases many existing expli ..."
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Cited by 99 (7 self)
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In this article, I explicitly solve dynamic portfolio choice problems, up to the solution of an ordinary differential equation (ODE), when the asset returns are quadratic and the agent has a constant relative risk aversion (CRRA) coefficient. My solution includes as special cases many existing explicit solutions of dynamic portfolio choice problems. I also present three applications that are not in the literature. Application 1 is the bond portfolio selection problem when bond returns are described by ‘‘quadratic term structure models.’ ’ Application 2 is the stock portfolio selection problem when stock return volatility is stochastic as in Heston model. Application 3 is a bond and stock portfolio selection problem when the interest rate is stochastic and stock returns display stochastic volatility. (JEL G11) There is substantial evidence of time variation in interest rates, expected returns, and asset return volatilities. Interest rates change over time, and although expected stock returns are not directly observed, future stock returns seem to be predictable using term structure variables and scaled prices such as dividend yields. 1 Similarly, there is welldocumented evidence