Document Type
Discussion Paper
Publication Date
2-1-1991
CFDP Number
970
CFDP Pages
22
Abstract
Efficient markets models assert that the price of each asset is equal to the optimal forecast of its ex-post or fundamental value. These models do not imply, however, that the covariance between two asset prices is given by the covariance between the ex-post values they respectively forecast: these two covariances can even have opposite signs. However, it is possible to place bounds on the covariance between asset prices given the covariance matrix of ex-post values. We present such bounds for both covariances and correlations and show how such bounds can be tightened using information beyond the covariance matrix of ex-post values. The methods are used to examine whether the historical correlation between the U.S. and U.K. stock markets 1919-1989 is warranted. The bounds on the warranted covariance are very wide and include the actual correlation.
Recommended Citation
Beltratti, Andrea E. and Shiller, Robert J., "Actual and Warranted Relations Between Asset Prices" (1991). Cowles Foundation Discussion Papers. 1213.
https://elischolar.library.yale.edu/cowles-discussion-paper-series/1213