Horizon-Dependent Risk Aversion and the Timing and Pricing of Uncertainty
Previous title: "Asset Pricing with Horizon-Dependent Risk Aversion"
December 2014 Number 703
Revised July 2023
JEL classification: D03, D90, G02, G12
Thomas Eisenbach, and
Martin C. Schmalz
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. Horizondependent
risk aversion helps resolve key puzzles in finance on the valuation of assets across maturities
and captures the term structure of equity risk premia and its dynamics.