Pricing Intertemporal Risk when Investment Opportunities Are Unobservable
79 Pages Posted: 23 Sep 2010 Last revised: 27 May 2018
Date Written: May 21, 2018
The Intertemporal Capital Asset Pricing Model (ICAPM) predicts that an unobservable factor capturing changes in expected market returns should be priced in the cross section. My Bayesian framework accounts for uncertainty in the intertemporal risk factor and gauges the effects of prior information about investment opportunities on model inferences. Whereas an uninformative-prior specification produces weak evidence that intertemporal risk is priced, incorporating prior information about market return predictability generates a large space of ex ante reasonable priors in which the estimated intertemporal risk factor is positively priced. Overall, the cross-sectional tests reject the CAPM and indicate support for the ICAPM.
Keywords: ICAPM, Intertemporal risk, Latent factor, Informative priors
JEL Classification: C11, G10, G12
Suggested Citation: Suggested Citation