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

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in AbstractWe study general equilibrium asset prices in a multi-period endowment economy when agents' risk aversion is allowed to depend on the maturity of the risk. We find horizon-dependent riskaversion preferences generate a decreasing term structure of risk premia if and only if volatility is stochastic. Our model can thus justify the recent empirical results on the term structure of risk premia if the pricing of volatility risk is downward sloping (in absolute value) in the data and if downward-sloping term structures of returns on a given market are driven solely by exposures to volatility risk. We test these predictions by estimating the price of volatility risk using index options data and by showing that the value premium is related to the exposure to volatility risk.

The Term Structure of the Price of Variance Risk

“…However, our findings are informative not only for option pricing. Specifically, the results presented in this paper support preference-based rationalizations of the termstructure of expected returns, such as the horizon-dependent risk aversion model of Andries et al (2014).…”

“…The latter two predictions are specific to the model by Andries et al (2014). We now explain the two different estimation procedures we use to test these hypotheses: a non-parametric estimation using short-horizon Sharpe ratios and a parametric estimation based on Christoffersen et al (2013).…”

“…1 By contrast, Andries, Eisenbach, and Schmalz (2014) maintain the long-run risk endowment economy of Bansal and Yaron (2004) but generalize the agents ' Epstein and Zin (1989) preferences to allow for horizon-dependent risk aversion. This framework predicts negative variance risk premia with a declining term structure (in absolute value) as a driver of the downward-sloping term structure of equity risk premia-both of which are amplified in times of high volatility.…”

Informed options trading on the implied volatility surface: A cross‐sectional approach

“…Using index options data, Andries, Eisenbach, and Schmalz () show that the preferences of horizon‐dependent risk aversion generate a decreasing term structure of risk premia, if and only if the volatility of underlying index is stochastic. They argue that the price of risk depends on the horizon, and that the horizon‐dependent risk appetite has a meaningful impact on asset pricing.…”

“…Andries, Eisenbach, Schmalz, and Wang (2015) investigate the price per unit of volatility risk at varying maturities and show that the price per unit of volatility risk parameters are negative and decrease in absolute value with maturity. Even if their finding is seemingly inconsistent with the standard asset pricing assumption of constant risk aversion across maturities, it confirms the horizon-dependent risk aversion asset pricing modeling approach.Using index options data, Andries, Eisenbach, and Schmalz (2014) show that the preferences of horizon-dependent risk aversion generate a decreasing term structure of risk premia, if and only if the volatility of underlying index is stochastic. They argue that the price of risk depends on the horizon, and that the horizon-dependent risk appetite has a meaningful impact on asset pricing.…”