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

Listed author(s):
  • Andries, Marianne

    ()

    (Toulouse School of Economics)

  • Eisenbach, Thomas M.

    (Federal Reserve Bank of New York)

  • Schmalz, Martin C.

    ()

    (University of Michigan)

We propose a model that addresses two fundamental challenges concerning the timing and pricing of uncertainty: established equilibrium asset pricing models require a controversial degree of preference for early resolution of uncertainty and do not generate the downward-sloping term structure of risk premia suggested by the data. Inspired by experimental evidence, we construct dynamically inconsistent preferences in which risk aversion decreases with the temporal horizon. The resulting pricing model can generate a term structure of risk premia consistent with empirical evidence, without forcing a particular preference for resolution of uncertainty or compromising the ability to match standard moments.

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Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 703.

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Length: 58 pages
Date of creation: 01 Dec 2014
Date of revision: 01 Mar 2017
Handle: RePEc:fip:fednsr:703
Note: Previous title: "Asset Pricing with Horizon-Dependent Risk Aversion"
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