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

CSDA Annals of Computational and Financial Econometrics, Forthcoming

Boston U. School of Management Research Paper No. 2464724

46 Pages Posted: 12 Jul 2014

See all articles by Cedric Okou

Cedric Okou

University of Quebec at Montreal (UQAM)

Eric Jacquier

Boston University School of Management; HEC Montreal - Department of Finance

Date Written: June 25, 2014

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 flat, that is, the risk-return slope coefficients are equal across horizons. When the regression model includes an intercept, the premise of a flat term structure of risk-return relationships is rejected. In contrast, there is no significant statistical evidence against the equality of slope coefficients 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

JEL Classification: G12

Suggested Citation

Okou, Cedric and Jacquier, Eric, Horizon Effect in the Term Structure of Long-Run Risk-Return Trade-Offs (June 25, 2014). CSDA Annals of Computational and Financial Econometrics, Forthcoming , Boston U. School of Management Research Paper No. 2464724, Available at SSRN: https://ssrn.com/abstract=2464724

Cedric Okou (Contact Author)

University of Quebec at Montreal (UQAM) ( email )

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Eric Jacquier

Boston University School of Management ( email )

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United States

HEC Montreal - Department of Finance ( email )

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