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How Important Is Intertemporal Risk for Asset Allocation?

Author

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  • Bruno Gerard

    (Norwegian School of Management–BI)

  • Guojun Wu

    (University of Houston)

Abstract

We test a conditional asset pricing model that includes long-term interest rate risk as a priced factor for four asset classes—large stocks, small stocks, and long-term Treasury and corporate bonds. We find that the interest risk premium is the main component of the risk premiums for bond portfolios, while representing a small fraction of total risk premiums for equities. This suggests that stocks, especially small stocks, are hedges against variations in the investment opportunity set. We estimate that, at average market volatility levels, investors earn annual premiums between 3.6% during expansions and 5.8% during recessions for bearing intertemporal risk alone.

Suggested Citation

  • Bruno Gerard & Guojun Wu, 2006. "How Important Is Intertemporal Risk for Asset Allocation?," The Journal of Business, University of Chicago Press, vol. 79(4), pages 2203-2242, July.
    • Handle: RePEc:ucp:jnlbus:v:79:y:2006:i:4:p:2203-2242
    DOI: 10.1086/503661
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    Cited by:

    1. Maio, Paulo, 2013. "Return decomposition and the Intertemporal CAPM," Journal of Banking & Finance, Elsevier, vol. 37(12), pages 4958-4972.
    2. Malamud, Semyon & Vilkov, Grigory, 2018. "Non-myopic betas," Journal of Financial Economics, Elsevier, vol. 129(2), pages 357-381.
    3. Perras, Patrizia & Wagner, Niklas, 2020. "Pricing equity-bond covariance risk: Between flight-to-quality and fear-of-missing-out," Journal of Economic Dynamics and Control, Elsevier, vol. 121(C).
    4. Jyri Kinnunen & Minna Martikainen, 2017. "Dynamic Autocorrelation and International Portfolio Allocation," Multinational Finance Journal, Multinational Finance Journal, vol. 21(1), pages 21-48, March.
    5. Jian Yang & Yinggang Zhou & Zijun Wang, 2010. "Conditional Coskewness in Stock and Bond Markets: Time-Series Evidence," Management Science, INFORMS, vol. 56(11), pages 2031-2049, November.
    6. Akbari, Amir & Carrieri, Francesca, 2023. "Global risk and market conditions," International Review of Economics & Finance, Elsevier, vol. 83(C), pages 51-70.
    7. Maio, Paulo & Santa-Clara, Pedro, 2012. "Multifactor models and their consistency with the ICAPM," Journal of Financial Economics, Elsevier, vol. 106(3), pages 586-613.
    8. Mazzotta, Stefano, 2008. "How important is asymmetric covariance for the risk premium of international assets?," Journal of Banking & Finance, Elsevier, vol. 32(8), pages 1636-1647, August.
    9. Michael Nwogugu, 2020. "Regret Theory And Asset Pricing Anomalies In Incomplete Markets With Dynamic Un-Aggregated Preferences," Papers 2005.01709, arXiv.org.

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