Are stocks riskier over the long run? Taking cues from economic theory

Doron Avramov, Doron Avramov, Scott Cederburg*, Katarína Lučivjanská

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

17 Scopus citations

Abstract

We study whether stocks are riskier or safer in the long run from the perspective of Bayesian investors who employ the long-run risk, habit formation, or prospect theory models to form prior beliefs about return dynamics. Economic theory delivers important guidance for long-run investment opportunities. Specifically, incorporating prior information from the habit formation or prospect theory models reinforces beliefs in mean reversion and inferences that stocks are safer over longer horizons. Conversely, investors with long-run risk priors perceive weaker mean reversion and riskier equities. Model-based information is particularly important for inferences about uncertainty in the dividend growth component of returns.

Original languageAmerican English
Pages (from-to)556-594
Number of pages39
JournalReview of Financial Studies
Volume31
Issue number2
DOIs
StatePublished - 1 Feb 2018

Bibliographical note

Publisher Copyright:
© The Author 2017.

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