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Horizon-Dependent Risk Aversion and the Timing and Pricing of Uncertainty

Marianne Andries, Thomas M. Eisenbach, and Martin Schmalz

Abstract

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.

Keywords

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

JEL codes

  • D03: Behavioral Microeconomics • Underlying Principles
  • D90: General
  • G12: Asset Pricing • Trading Volume • Bond Interest Rates

Reference

Marianne Andries, Thomas M. Eisenbach, and Martin Schmalz, Horizon-Dependent Risk Aversion and the Timing and Pricing of Uncertainty, March 2017.

See also

Published in

March 2017