Horizon Bias and the Term Structure of Equity Returns

Abstract

Recent work shows that the term structure of optimism has significant time-series variation and is, on average, upward sloping (horizon bias). We examine whether the horizon bias can explain the time-series variation in the equity term structure. We use analyst earnings forecasts to measure the degree of the horizon bias in the stock market. Consistent with the intuition from a stylized present value model, we find that periods of above-average horizon bias are associated with negative term premia, whereas periods of below-average horizon bias are associated with positive term premia. Furthermore, the horizon bias negatively predicts realized equity term premia.

Keywords: term structure of equities, extrapolation, optimism bias