Should Investors Learn About the Timing of Equity Risk?

68 Pages Posted: 2 Jun 2020

See all articles by Michael Hasler

Michael Hasler

University of Texas at Dallas, Naveen Jindal School of Management, Department of Finance

Mariana Khapko

University of Toronto - Finance Area; Swedish House of Finance

Roberto Marfè

University of Turin - Collegio Carlo Alberto

Date Written: May 1, 2020

Abstract

The term structure of equity risk has been shown to be downward sloping. We capture this feature using return dynamics driven by both a transitory and a permanent component. We study the asset allocation and portfolio performance when transitory and permanent components cannot be observed and therefore need to be estimated. Strategies that account for the observed timing of equity risk outperform those that do not, particularly so out of sample. Indeed, the mean (median) certainty equivalent return increases from about 13% (12%) to about 21% (15%) because properly modeling the timing of equity risk implies surges in portfolio returns.

Keywords: portfolio choice, learning, short-term risks, long-term risks

JEL Classification: G11, G12, G13

Suggested Citation

Hasler, Michael and Khapko, Mariana and Marfè, Roberto, Should Investors Learn About the Timing of Equity Risk? (May 1, 2020). Journal of Financial Economics (JFE), 2020, Available at SSRN: https://ssrn.com/abstract=3590256

Michael Hasler (Contact Author)

University of Texas at Dallas, Naveen Jindal School of Management, Department of Finance ( email )

800 West Campbell
Richarson, TX 75080
United States

Mariana Khapko

University of Toronto - Finance Area ( email )

Toronto, Ontario M5S 3E6
Canada

Swedish House of Finance ( email )

Drottninggatan 98
Stockholm
Sweden

Roberto Marfè

University of Turin - Collegio Carlo Alberto ( email )

Piazza Arbarello 8
Torino, Torino 10122
Italy

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