Do Subjective Expectations Explain Asset Pricing Puzzles?

42 Pages Posted: 22 Sep 2008

See all articles by Gurdip Bakshi

Gurdip Bakshi

Temple University - Fox School of Business and Management; Fox School of Business

Georgios Skoulakis

University of British Columbia (UBC) - Division of Finance

Multiple version iconThere are 4 versions of this paper

Date Written: September 19, 2008


The structural uncertainty model with Bayesian learning, advanced by Weitzman (2007), provides a framework for gauging the effect of structural uncertainty on asset prices and risk premiums, and has quite a few appealing attributes. In this paper, we provide an operational version of his approach that incorporates realistic priors about consumption growth volatility while guaranteeing finite asset pricing quantities. Our modification allows characterization of the predictive density for consumption growth that is virtually indistinguishable from the heavy-tailed t distribution, but importantly possesses a finite moment generating function. The resulting asset pricing model with subjective expectations yields bounded expected utility, well-specified intertemporal marginal rate of substitution, and expressions for equity premium and riskfree return. Applying economic theory in the context of subjective expectations reveals that explaining the historical equity premium and riskfree return requires implausible levels of structural uncertainty. Furthermore, these implausible prior beliefs share disaster probabilities that almost coincide with those implied by more realistic priors. At the same time, the two sets of prior beliefs have diametrically opposite asset pricing implications: one asserting, and the other contradicting, the antipuzzle view.

Keywords: subjective expectations, learning, structural uncertainty, priors, predictive density of consumption growth, equity premium, riskfree return

JEL Classification: D34, G12

Suggested Citation

Bakshi, Gurdip S. and Bakshi, Gurdip S. and Skoulakis, Georgios, Do Subjective Expectations Explain Asset Pricing Puzzles? (September 19, 2008). Available at SSRN: or

Gurdip S. Bakshi

Temple University - Fox School of Business and Management ( email )

Philadelphia, PA 19122
United States

HOME PAGE: http://

Fox School of Business ( email )

Department of Finance
Philadelphia, PA 19022
United States
215-204-6117 (Phone) (Fax)

HOME PAGE: http://

Georgios Skoulakis (Contact Author)

University of British Columbia (UBC) - Division of Finance ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2

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