Understanding Short- versus Long-Run Risk Premia

Authors


  • We would like to thank John Doukas (the editor), an anonymous referee, Davide Silvestrini (JP Morgan), Paul Whelan (Imperial College Business School), and conference participants at FEBS (London, June 2012), EFMA (Barcelona, June 2012), and FMA (Atlanta, October 2012) for useful comments and suggestions. The usual disclaimer applies.

Abstract

This paper studies the link between short- and long-run risk premia. We extract short-term risk premia from contemporaneous information on short-term futures and cash equity markets under the assumption of no arbitrage. Predictability regressions reveal that short-term risk premia capture different information from long-run risk premia. Counter to the intuition that a high price of risk commands high returns, high short-run risk premia on dividend claims predict low returns on the index. While inconsistent with models featuring either habit persistence or long-run risk, the results may be reconciled with some models of uncertainty aversion.

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