Conditional Dynamics and the Multi-Horizon Risk-Return Trade-Off
37 Pages Posted: 24 Dec 2018 Last revised: 3 May 2019
Date Written: April 30, 2019
We propose testing asset-pricing models using multi-horizon returns (MHR). MHR serve as powerful source of conditional information that is economically important and not data-mined. We apply MHR-based testing to linear factor models. These models seek to construct the unconditionally mean-variance efficient portfolio. We reject many popular models that deliver high maximum Sharpe ratios in a single-horizon setting, due to persistent specification errors that manifest in large pricing errors for longer-horizon returns. MHR reveal that strong intertemporal dynamics of the factor loadings in the SDF representation is needed to account for the cross-section of returns jointly across multiple horizons.
Keywords: multi-horizon returns, linear factor models, stochastic discount factor
JEL Classification: G12, C51
Suggested Citation: Suggested Citation