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Risk Premia: Short and Long-term

  • Stanislav Khrapov

    ()

    (New Economic School)

Hansen (2011) considers risks associated with cash flows at alternative horizons. He shows that in the long run many investor preference specifications do not imply risk premia substantially different from those implied by simple expected utility model. The main result of this paper is that the generalized disappointment aversion model of Routledge & Zin (2010) amplifies risk premium not only in the short run but also for assets that pay off long into the future. The reason behind this result is that this utility alters the risk-neutral distribution of future economy outcomes relative to the expected utility. The latter shares the risk-neutral distribution with more general Epstein & Zin (1989) recursive utility. I also analyze the risk premium term structure implied by the three utilities and find that its slope critically depends on the volatility of the transient payoff component with high enough volatility leading to negatively sloped term structure.

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Paper provided by Center for Economic and Financial Research (CEFIR) in its series Working Papers with number w0169.

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Length: 37 pages
Date of creation: Jan 2012
Date of revision:
Handle: RePEc:cfr:cefirw:w0169
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  1. John Y. Campbell & John H. Cochrane, 1994. "By force of habit: a consumption-based explanation of aggregate stock market behavior," Working Papers 94-17, Federal Reserve Bank of Philadelphia.
  2. Bonomo, Marco & Garcia, René & Meddahi, Nour & Tédongap, Roméo, 2010. "Generalized Disappointment Aversion, Long Run Volatility Risk and Asset Prices," TSE Working Papers 10-187, Toulouse School of Economics (TSE).
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  4. David K. Backus & Bryan R. Routledge & Stanley E. Zin, 2005. "Exotic Preferences for Macroeconomists," NBER Chapters, in: NBER Macroeconomics Annual 2004, Volume 19, pages 319-414 National Bureau of Economic Research, Inc.
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  11. Jules van Binsbergen & Michael Brandt & Ralph Koijen, 2012. "On the Timing and Pricing of Dividends," American Economic Review, American Economic Association, vol. 102(4), pages 1596-1618, June.
  12. Berg, Tobias, 2010. "The term structure of risk premia: new evidence from the financial crisis," Working Paper Series 1165, European Central Bank.
  13. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
  14. Bryan R. Routledge & Stanley E. Zin, 2010. "Generalized Disappointment Aversion and Asset Prices," Journal of Finance, American Finance Association, vol. 65(4), pages 1303-1332, 08.
  15. Ravi Bansal & Amir Yaron, 2004. "Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles," Journal of Finance, American Finance Association, vol. 59(4), pages 1481-1509, 08.
  16. Tauchen, George, 1986. "Finite state markov-chain approximations to univariate and vector autoregressions," Economics Letters, Elsevier, vol. 20(2), pages 177-181.
  17. Lemke, Wolfgang & Werner, Thomas, 2009. "The term structure of equity premia in an affine arbitrage-free model of bond and stock market dynamics," Working Paper Series 1045, European Central Bank.
  18. Constantinides, George M, 1990. "Habit Formation: A Resolution of the Equity Premium Puzzle," Journal of Political Economy, University of Chicago Press, vol. 98(3), pages 519-43, June.
  19. Daniel, Kent & Marshall, David, 1997. "Equity-Premium And Risk-Free-Rate Puzzles At Long Horizons," Macroeconomic Dynamics, Cambridge University Press, vol. 1(02), pages 452-484, June.
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