Are Stock Prices Too Volatile and Returns Too High? A Reassessment of the Empirical Evidence Using a Dynamic Version of the CAPM

Using long-run data and a VAR approach, the study investigates whether US and UK stock markets have experienced excessively volatile prices and excessively high returns. Present value models, developed in a constant and non-constant risk CAPM framework, are used as benchmarks with which to compare market data. The results show that when a time-varying risk premium is incorporated into the analysis, the view that historical prices have been consistently too volatile and their returns too high cannot be supported. According to risk-adjusted present value relationships, our evidence also suggests that the recently reported overvaluation of markets is unfounded