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In search of preference shock risks: Evidence from longevity risks and momentum profits

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  • Chen, Zhanhui
  • Yang, Bowen

Abstract

Time-preference shocks affect agents’ preferences for assets with different durations. We consider longevity risk as a source of time-preference shocks and model it in the recursive preferences setting. This implies a consumption-based three-factor model, including longevity risk, consumption growth rate, and the market portfolio, where longevity has a negative price of risk. Empirically, this model explains many well-known cross-sectional portfolios. Notably, we find that longevity risk and the momentum factor share a common business cycle component, i.e., short-run consumption risks. Prior winners (losers) provide hedging against mortality (longevity) risk and thus have higher (lower) expected returns, because winners have higher dividend growth and shorter equity durations than losers. Time-varying longevity risk captures most momentum profits over time, including the large momentum crashes observed in the data.

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  • Chen, Zhanhui & Yang, Bowen, 2019. "In search of preference shock risks: Evidence from longevity risks and momentum profits," Journal of Financial Economics, Elsevier, vol. 133(1), pages 225-249.
    • Handle: RePEc:eee:jfinec:v:133:y:2019:i:1:p:225-249
    DOI: 10.1016/j.jfineco.2019.01.004
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    Cited by:

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    2. Oliver de Groot & Alexander W. Richter & Nathaniel A. Throckmorton, 2022. "Valuation risk revalued," Quantitative Economics, Econometric Society, vol. 13(2), pages 723-759, May.
    3. Chaonan Lin & Nien‐Tzu Yang & Robin K. Chou & Kuan‐Cheng Ko, 2022. "A timing momentum strategy," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 62(S1), pages 1339-1379, April.
    4. Braun, Alexander & Braun, Julia & Weigert, Florian, 2023. "Extreme weather risk and the cost of equity," CFR Working Papers 23-08, University of Cologne, Centre for Financial Research (CFR).
    5. Chen, Chang-Chih & Chang, Chia-Chien & Sun, Edward W. & Yu, Min-Teh, 2022. "Optimal decision of dynamic wealth allocation with life insurance for mitigating health risk under market incompleteness," European Journal of Operational Research, Elsevier, vol. 300(2), pages 727-742.

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    More about this item

    Keywords

    Time-preference shocks; Longevity risk; Momentum profits; Equity durations; Consumption-based models;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • J11 - Labor and Demographic Economics - - Demographic Economics - - - Demographic Trends, Macroeconomic Effects, and Forecasts

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