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

Author

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  • Marianne Andries
  • Thomas M Eisenbach
  • Martin C Schmalz

Abstract

Inspired by experimental evidence, we amend the recursive utility model to let risk aversion decrease with the temporal horizon. Our pseudo-recursive preferences remain tractable and retain appealing features of the long-run risk framework, notably its success at explaining asset pricing moments. In addition, our model addresses two challenges to the standard model. Calibrating the agents’ preferences to explain the equity premium no longer implies an extreme preference for early resolutions of uncertainty. Horizon-dependent risk aversion helps resolve key puzzles in finance on the valuation of assets across maturities and captures the term structure of equity risk premiums and its dynamics.

Suggested Citation

  • Marianne Andries & Thomas M Eisenbach & Martin C Schmalz, 2024. "Horizon-Dependent Risk Aversion and the Timing and Pricing of Uncertainty," The Review of Financial Studies, Society for Financial Studies, vol. 37(11), pages 3272-3334.
    • Handle: RePEc:oup:rfinst:v:37:y:2024:i:11:p:3272-3334.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhae049
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    More about this item

    Keywords

    D03; D90; G02; G12;
    All these keywords.

    JEL classification:

    • D03 - Microeconomics - - General - - - Behavioral Microeconomics: Underlying Principles
    • D90 - Microeconomics - - Micro-Based Behavioral Economics - - - General
    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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