Understanding Risk and Return

Abstract
This paper uses an equilibrium multifactor model to interpret the cross-sectional pattern of postwar U.S. stock and bond returns. Priced factors include the return on a stock index, revisions in fore- casts of future stock returns (to capture intertemporal hedgiqg ef- fects), and revisions in forecasts of future labor income growth (proxies for the return on human capital). Aggregate stock market risk is the main factor determining excess returns; but in the pres- ence of human capital or stock market mean reversion, the coeffi- cient of relative risk aversion is much higher than the price of stock market risk.