Horizon Effect in the Term Structure of Long-Run Risk-Return Trade-Offs

Cedric Okou and Eric Jacquier

CIRANO Working Papers from CIRANO

Abstract: The horizon effect in the long-run predictive relationship between market excess return and historical market variance is investigated. To this end, the asymptotic multivariate distribution of the term structure of risk-return trade-offs is derived, accounting for short- and long-memory in the market variance dynamics. A rescaled Wald statistic is used to test whether the term structure of risk-return trade-offs is at, that is, the risk-return slope coeffcients are equal across horizons. When the regression model includes an intercept, the premise of a at term structure of risk-return relationships is rejected. In contrast, there is no significant statistical evidence against the equality of slope coeffcients from constrained risk-return regressions estimated at different horizons. A smoothed cross-horizon estimate is then proposed for the trade-off intensity at the market level. The findings underscore the importance of economically motivated restrictions to improve the estimation of intertemporal asset pricing models.

Keywords: Horizon effect; Stock return predictability; Realized variance; Short-memory; Long-memory (search for similar items in EconPapers)
Date: 2014-07-01
New Economics Papers: this item is included in nep-rmg
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Persistent link: https://EconPapers.repec.org/RePEc:cir:cirwor:2014s-36

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