Conclusion

Following the efficient markets hypothesis activity prices are determined conditionally on the type of information valued by investors. The equivalent risk-neutral valuation predicts that investors should not expect to earn more than normal returns, whereas in static predictive regressions for the asset and housing markets valuation ratios are positively correlated to forthcoming returns. A cognitive science view suggests, that price under- or overvaluation could occur, when agent expectations are formed on the basis of heuristic rules. The expectations hypothesis states, that long rates should equal expected average short rates and forward rates should model expected future spot rates in the market for fixed income securities. In static spot rate spread regressions the term spread forecasts holding period returns. Conversely, forward rate regressions have a well-defined dynamic structure and confirm the predictions of the hypothesis. Finally, the volatility properties of the stochastic discount factor can be interpreted as evidence regarding the completeness of financial markets.