Systematic Risk and the Horizon Problem

Pao L. Cheng and M. King Deets

Journal of Financial and Quantitative Analysis, 1973, vol. 8, issue 2, 299-316

Abstract: In so far as the concept of systematic risk is predicated on the Sharpe-Lintner theory of capital market equilibrium [5, 4], the time-horizon of systematic risk must conform with the time-horizon of market equilibrium. Since it has been suggested that market equilibrium is instantaneous [3, p. 188], it would follow that systematic risk should also be instantaneous. This paper is, therefore, concerned with the evaluation and measurement of instantaneous risk. Although Jensen [3] has made a similar attempt in a much larger study, we have reason to believe it is not satisfactory. We shall then begin in Section I by discussing Jensen's approach to the horizon problem. In Section II, an alternative procedure of evaluating systematic risk is suggested. Section III concludes the paper by comparing estimates of instantaneous risks based upon weekly returns of 30 Dow-Jones stocks. The motivation behind the paper is obvious. A correct formulation of instantaneous systematic risk is not only a logical extension of the capital market equilibrium theory but is also a yardstick for measuring portfolio performance in terms of risk and return.

Date: 1973
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