Article1997

GROWTH-OPTIMAL PORTFOLIO RESTRICTIONS ON ASSET PRICING MODELS

123 citations0/0 files storedMacroeconomic Dynamics

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Financial Markets and Investment Strategies Stochastic processes and financial applications Economic theories and models

Abstract

We show that absence of arbitrage in frictionless markets implies a lower bound on the average of the logarithm of the reciprocal of the stochastic discount factor implicit in asset pricing models. The greatest lower bound for a given asset menu is the average continuously compounded return on its growth-optimal portfolio. We use this bound to evaluate the plausibility of various parametric asset pricing models to characterize financial market puzzles such as the equity premium puzzle and the risk-free rate puzzle. We show that the insights offered by the growth-optimal bounds differ substantially from those obtained by other nonparametric bounds.

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References

1985The equity premium: A puzzle 1999By Force of Habit: A Consumption‐Based Explanation of Aggregate Stock Market Behavior 1979Martingales and arbitrage in multiperiod securities markets 1990Habit Formation: A Resolution of the Equity Premium Puzzle 1990Asset Prices under Habit Formation and Catching up with the Joneses 1988Theory of Financial Decision Making.1976The Valuation of Uncertain Income Streams and the Pricing of Options 1989Optimal consumption and portfolio policies when asset prices follow a diffusion process

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