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Market Equilibrium and the Cost of Capital with Heterogeneous Investment Horizons

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  • Moshe Levy

    (Jerusalem School of Business, The Hebrew University, Jerusalem 91905, Israel)

  • Haim Levy

    (Jerusalem School of Business, The Hebrew University, Jerusalem 91905, Israel)

Abstract

Expected returns, variances, betas, and alphas are all non-linear functions of the investment horizon. This seems to be a fatal conceptual problem for the capital asset pricing model (CAPM), which assumes a unique common horizon for all investors. We show that under the standard assumptions, the theoretical CAPM equilibrium surprisingly holds with the 1-period parameters, even when investors have heterogeneous and possibly much longer horizons. This is true not only for risk-averse investors, but for any investors with non-decreasing preferences, including prospect theory investors. Thus, the widespread practice of using monthly betas to estimate the cost of capital is theoretically justified.

Suggested Citation

  • Moshe Levy & Haim Levy, 2024. "Market Equilibrium and the Cost of Capital with Heterogeneous Investment Horizons," Risks, MDPI, vol. 12(3), pages 1-16, February.
    • Handle: RePEc:gam:jrisks:v:12:y:2024:i:3:p:44-:d:1348475
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    References listed on IDEAS

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