Norwegian School of Economics (NHH)
Institutional Affiliation: Norwegian School of Economics
NBER Working Papers and Publications
|December 2018||Conditional Dynamics and the Multi-Horizon Risk-Return Trade-Off|
with Mikhail Chernov, Lars A. Lochstoer: w25361
We propose testing asset-pricing models using multi-horizon returns (MHR). MHR serve as powerful source of conditional information that is economically important and not data-mined. We apply MHR-based testing to linear factor models. These models seek to construct the unconditionally mean-variance efficient portfolio. We reject all state-of-the-art models that imply high maximum Sharpe ratios in a single-horizon setting. Thus, the models do a poor job in accounting for the risk-return trade-off at longer horizons. Across the different models, the mean absolute pricing errors associated with MHR are positively related to the magnitude of maximal Sharpe ratio in the single-horizon setting. Model misspecification manifests itself in strong intertemporal dynamics of the factor loadings in the ...