J Real Estate Finan Econ (2007) 34:233–256
Equilibrium Correlations of Asset Price and Return
Charles Ka Yui Leung
Published online: 3 April 2007
© Springer Science + Business Media, LLC 2007
Abstract Two empirical questions concerning the equity and housing have been
studied extensively: (1) Are the price and return serially correlated, and (2) What
is the optimal weight of housing in the portfolio? The answer to the second question
crucially depends on the cross-correlation of assets. This paper complements the
literature by building a simple dynamic general equilibrium with fully rational
agents, and obtain closed form solutions for the implied auto- and cross-correlations.
The length of time horizon, as well as the persistence of economic shock matter.
Implications and future research directions are then discussed.
Keywords Rational expectation · Price and return · Serial and cross correlation ·
Market efﬁciency · Predictability
JEL E30 · G10 · R20
Introduction and Motivation
This paper attempts to shed light on two empirical questions concerning the equity
and housing: (1) Are the price and return of stock, as well as housing, serially
correlated, or, at least partly predictable, (for instance, see Case and Shiller 1989,
1990)? and (2) What is the optimal weight of housing in the household portfolio?
As observed by Hwang and Quigley (2003), the serial correlations of asset prices
(the ﬁrst question) are often quoted as evidence for market inefﬁciency, or even
a basis to question the rationality of economic agents. (Cochrane 2001, especially
Forthcoming in Journal of Real Estate Finance and Economics.
C. K. Y. Leung (
Department of Economics and Finance, City University of Hong Kong,
Kowloon Tong, Hong Kong