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

96 Pages Posted: 9 Dec 2014 Last revised: 12 Jul 2023

See all articles by Marianne Andries

Marianne Andries

University of Southern California

Thomas M. Eisenbach

Federal Reserve Banks - Federal Reserve Bank of New York

Martin C. Schmalz

CEPR; University of Oxford - Finance; CESifo; European Corporate Governance Institute (ECGI)

Date Written: April 1, 2019

Abstract

Inspired by experimental evidence, we amend the recursive utility model to let risk aversion decrease with the temporal horizon. Our pseudo-recursive preferences remain tractable and retain appealing features of the long-run risk framework, notably its success at explaining asset pricing moments. In addition, our model addresses two challenges to the standard model. Calibrating the agents’ preferences to explain the equity premium no longer implies an extreme preference for early resolutions of uncertainty. Horizon-dependent risk aversion helps resolve key puzzles in finance on the valuation of assets across maturities and captures the term structure of equity risk premia and its dynamics.

Keywords: risk aversion, early resolution, term structure, volatility risk

JEL Classification: D03, D90, G02, G12

Suggested Citation

Andries, Marianne and Eisenbach, Thomas M. and Schmalz, Martin C. and Schmalz, Martin C., Horizon-Dependent Risk Aversion and the Timing and Pricing of Uncertainty (April 1, 2019). FRB of New York Staff Report No. 703. Rev. January 2024, Available at SSRN: https://ssrn.com/abstract=2535919 or http://dx.doi.org/10.2139/ssrn.2535919

Marianne Andries

University of Southern California ( email )

2250 Alcazar Street
Los Angeles, CA 90089
United States

Thomas M. Eisenbach (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States
212-720-6089 (Phone)

HOME PAGE: http://teisenbach.github.io/

Martin C. Schmalz

University of Oxford - Finance ( email )

United States

CEPR ( email )

London
United Kingdom

CESifo ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

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