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Horizon Effects in the Pricing Kernel: How Investors Price Short-Term Versus Long-Term Risks

Published online by Cambridge University Press:  14 March 2025

Joost Driessen Open the ORCID record for Joost Driessen [Opens in a new window] ,
Joren Koëter  and
Ole Wilms
Joost Driessen*
Affiliation:
Tilburg University, Department of Finance
Joren Koëter
Affiliation:
Rotterdam School of Management, Erasmus University koeter@rsm.nl
Ole Wilms
Affiliation:
Universität Hamburg, Department of Economics and Tilburg University, Department of Finance ole.wilms@uni-hamburg.de
*
j.j.a.g.driessen@uvt.nl (corresponding author)
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Abstract

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We show that investors price short-term stock market outcomes very different from outcomes that occur further into the future. To this end, we introduce the expected forward pricing kernel and decompose long-term pricing kernels into short-term and expected forward pricing kernels. Using index options, we find that kernels with maturities of up to 12 months are U-shaped and show that this results from the shape of the 1-month pricing kernel. Once we remove the impact of the 1-month kernel, the expected forward kernels are in line with standard long-run risk models in terms of their shape, level, and time-series variation.

Information

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 60 , Issue 8 , December 2025 , pp. 3791 - 3825
Creative Commons
Creative Common License - CCCreative Common License - BY
This is an Open Access article, distributed under the terms of the Creative Commons Attribution licence (http://creativecommons.org/licenses/by/4.0), which permits unrestricted re-use, distribution and reproduction, provided the original article is properly cited.
Copyright
© The Author(s), 2025. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

Footnotes

We thank Sebastian Ebert, Jonas Nygaard Eriksen, Can Gao, Stefano Giglio, Jia-Hau Guo, Jens Jackwerth, Kris Jacobs, Ben Matthies, Tobias Sichert, Kaushik Vasudevan, and seminar participants at the 2023 SFS Cavalcade NA, 2023 SGF, 2021 SAFE Asset Pricing Workshop, 2021 EFMA, 2018 SITE, and Tilburg University for helpful comments and discussions on the topic.

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