Risk Premia: Short and Long-term

Stanislav Khrapov

No w0169, Working Papers from Center for Economic and Financial Research (CEFIR)

Abstract: 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.

Keywords: term structure of risk premium; Epstein-Zin utility; generalized disappointment aversion; finite state economy; Markov chain (search for similar items in EconPapers)
JEL-codes: G12 (search for similar items in EconPapers)
Pages: 37 pages
Date: 2012-01
New Economics Papers: this item is included in nep-upt
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Working Paper: Risk Premia: Short and Long-term (2012)
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