Investments, tenth edition

  Extensions to the CAPM May Resolve the Equity Premium Puzzle 

 Constantinides argues that the standard CAPM can be extended to account for observed 

excess returns by relaxing some of its assumptions, in particular, by recognizing that con-

sumers face uninsurable and idiosyncratic income shocks, for example, the loss of employ-

ment.  

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   The prospect of such events is higher in economic downturns and this observation 

takes us a long way toward understanding the means and variances of asset returns as well 

as their variation along the business cycle.

 

 In addition, life-cycle considerations are important and often overlooked. Borrowing 

constraints become important when placed in the context of the life cycle. The imaginary 

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 Philippe Jurion and William N. Goetzmann, “Global Stock Markets in the Twentieth Century,”  Journal 

of Finance  54, no. 3 (June 1999). 

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 George M. Constantinides, “Understanding the Equity Risk Premium Puzzle,” in  Handbooks in Finance: Hand-

book of the Equity Risk Premium,  ed. Rajnish Mehra (Amsterdam: Elsevier, 2008), pp. 331–59.