Horizon Pricing

Abstract

In a classical one-period asset-pricing model, high expected returns are achieved only by accepting high levels of systematic risk. Allowing for heterogenous investment horizons across investors, some risks that require a premium over a particular horizon, may seem less consequential to investors facing a different investment horizon. This paper studies the pricing of commonly used systematic risk factors across investment horizons. We find that liquidity risk exhibits a premium that may constitute abnormal return (alpha) for patient investors because liquidity fluctuations are less apparent for long horizons. In contrast, market, value, and return-on-equity factors are predominantly priced when systematic risk is measured using long horizon returns. While value and return-on-equity appear to be characteristics at short horizons they behave like systematic risk factors at long horizons. Size, momentum, and investment, behave like characteristics at all horizons. The results highlight the importance of considering investment horizon in determining whether a cross-sectional return spread is alpha or a premium for systematic risk.

Keywords: asset pricing model, investment horizon, factors, characteristics

JEL Classification: G1, G12