Rational Asset Prices


  • George M. Constantinides

    Search for more papers by this author
    • University of Chicago and NBER. I thank John Campbell, Gene Fama, Chris Geczy, Lars Hansen, John Heaton, Rajnish Mehra, L'uboš Pástor Dick Thaler, and particularly Alon Brav and John Cochrane, for their insightful comments and constructive criticism. Finally, I thank Lior Menzly for his excellent research assistance and insightful comments throughout this project. Naturally, I remain responsible for errors.


The mean, covariability, and predictability of the return of different classes of financial assets challenge the rational economic model for an explanation. The unconditional mean aggregate equity premium is almost seven percent per year and remains high after adjusting downwards the sample mean premium by introducing prior beliefs about the stationarity of the price–dividend ratio and the (non)forecastability of the long-term dividend growth and price—dividend ratio. Recognition that idiosyncratic income shocks are uninsurable and concentrated in recessions contributes toward an explanation. Also borrowing constraints over the investors' life cycle that shift the stock market risk to the saving middle-aged consumers contribute toward an explanation.