Horizon-Specific Macroeconomic Risks and the Cross-Section of Expected Returns
New University of Lisbon - Nova School of Business and Economics
London School of Economics & Political Science (LSE)
December 15, 2015
Abstract:
We show that decomposing macroeconomic risks across horizon is key to uncover a tight link between risk premia and the real economy. Exposure in four-year returns to innovations in macroeconomic growth and volatility with a matching half-life of over four years is priced in a wide variety of test assets. Shorter-term risks are not priced. Importantly, we show that long-term growth and volatility capture largely common risk. We then propose a single, long-term, macroeconomic risk factor which drives out standard long-run risk measures and performs similar to the Fama-French three-factor model in cross-sectional tests. Our empirical results strongly support the use of long-horizon betas to measure macroeconomic risks in asset returns.
Number of Pages in PDF File: 67
Keywords: Cross-sectional tests, firm-level stock returns, long horizons, macroeconomic risks, consumption, linear multifactor models
JEL Classification: E32, E44, G12
