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Horizon-dependent risk aversion and the timing and pricing of uncertainty

Author

Listed:
  • Andries, Marianne

    () (Toulouse School of Economics)

  • Eisenbach, Thomas M.

    (Federal Reserve Bank of New York)

  • Schmalz, Martin C.

    () (University of Michigan)

Abstract

We address two fundamental critiques of established asset pricing models: that they (1) require a controversial degree of preference for early resolution of uncertainty; and (2) do not match the term structures of risk premia observed in the data. Inspired by experimental evidence, we construct preferences in which risk aversion decreases with the temporal horizon. The resulting model implies term structures of risk premia consistent with the evidence, including time-variations and reversals in the slope, without imposing a particular preference for early or late resolutions of uncertainty or compromising on the ability to match standard moments in the returns distributions.

Suggested Citation

  • Andries, Marianne & Eisenbach, Thomas M. & Schmalz, Martin C., 2014. "Horizon-dependent risk aversion and the timing and pricing of uncertainty," Staff Reports 703, Federal Reserve Bank of New York, revised 01 Mar 2018.
  • Handle: RePEc:fip:fednsr:703
    Note: Previous title: "Asset Pricing with Horizon-Dependent Risk Aversion"
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    References listed on IDEAS

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    Cited by:

    1. Eisenbach, Thomas M. & Schmalz, Martin C., 2016. "Anxiety in the face of risk," Journal of Financial Economics, Elsevier, vol. 121(2), pages 414-426.
    2. Koijen, Ralph & van Binsbergen, Jules H., 2015. "The Term Structure of Returns: Facts and Theory," CEPR Discussion Papers 10633, C.E.P.R. Discussion Papers.
    3. Andries, Marianne & Eisenbach, Thomas M. & Schmalz, Martin C. & Wang, Yichuan, 2015. "The term structure of the price of variance risk," Staff Reports 736, Federal Reserve Bank of New York.
    4. repec:eee:jfinec:v:128:y:2018:i:3:p:486-503 is not listed on IDEAS

    More about this item

    Keywords

    risk aversion; early resolution; term structure; volatility risk;

    JEL classification:

    • D03 - Microeconomics - - General - - - Behavioral Microeconomics: Underlying Principles
    • D90 - Microeconomics - - Micro-Based Behavioral Economics - - - General
    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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