Conditional Dynamics and the Multi-Horizon Risk-Return Trade-Off

60 Pages Posted: 17 Dec 2018

See all articles by Mikhail Chernov

Mikhail Chernov

UCLA Anderson

Lars A. Lochstoer

University of California, Los Angeles (UCLA) - Anderson School of Management

Stig H.R. Lundeby

Norwegian School of Economics (NHH)

Multiple version iconThere are 3 versions of this paper

Date Written: December 2018

Abstract

We propose testing asset-pricing models using multi-horizon returns (MHR). MHR effectively generate a new set of test assets that are endogenous to the model and that identify a broad set of possible conditional misspecifications. We apply MHR-based testing to prominent linear factor models and show that these models typically do a poor job of pricing longer-horizon returns, with pricing errors of similar magnitude as the risk premiums they were designed to explain. We trace the errors to the conditional factor dynamics. Explicitly incorporating factor timing in the models often makes mispricing worse, posing a challenge for future research.

Suggested Citation

Chernov, Mikhail and Lochstoer, Lars A. and Lundeby, Stig, Conditional Dynamics and the Multi-Horizon Risk-Return Trade-Off (December 2018). NBER Working Paper No. w25361, Available at SSRN: https://ssrn.com/abstract=3302481

Mikhail Chernov (Contact Author)

UCLA Anderson ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

Lars A. Lochstoer

University of California, Los Angeles (UCLA) - Anderson School of Management ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

Stig Lundeby

Norwegian School of Economics (NHH) ( email )

Helleveien 30
Bergen, NO-5045
Norway

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