Equity Risk Premium and Time Horizon : What do the U.S. Secular Data Say ?
AbstractAn ex-ante equity risk premium is the difference between the expected return of a risky asset at time t for a given future time horizon and an equivalent maturity risk-free interest rate. Using annual US secular data from 1871 to 2008, this study aims to model simultaneously the measures and the explanations of ex-ante equity risk premia for two polar horizons: the one period ahead horizon (i.e. the "short term" premium) and the infinite time horizon (i.e. the "long term" premium). Expectations being represented by traditional adaptive processes, large disparities in the dynamics of the two premia are evidenced. According to the conditional CAPM, each premium is at time t explained by the product of the price of risk by the expected variance of returns, these two magnitudes being horizon dependant. The expected variances depend on the past values of the centered squared returns (we found 5 and 8 years for the one year and the infinite horizon, respectively). For each horizon, the price of risk is determined by a spread of interest rates capturing economic factors of uncertainty and by an unobservable variable determined according to the kalman filter methodology (i.e. a state variable). The state variables are supposed to capture the influence of hidden variables and of non directly measurable psychological effects. The model gives a valuable representation of the "short term" and "long term" premia.
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Bibliographic InfoPaper provided by University of Paris West - Nanterre la Défense, EconomiX in its series EconomiX Working Papers with number 2010-22.
Length: 39 pages
Date of creation: 2010
Date of revision:
equity risk premium; time horizon;
Other versions of this item:
- Prat, Georges, 2013. "Equity risk premium and time horizon: What do the U.S. secular data say?," Economic Modelling, Elsevier, vol. 34(C), pages 76-88.
- Georges Prat, 2012. "Equity risk premium and time horizon: what do the U.S. secular data say?," Working Papers 12-06, Association Française de Cliométrie (AFC).
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-12-04 (All new papers)
- NEP-FMK-2010-12-04 (Financial Markets)
- NEP-UPT-2010-12-04 (Utility Models & Prospect Theory)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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Blog mentionsAs found by EconAcademics.org, the blog aggregator for Economics research:
- The psychology of the equity risk premium
by Economic Logician in Economic Logic on 2011-01-12 15:03:00
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