Long Memory and the Term Structure of Risk

Posted: 16 Oct 2008

See all articles by Peter C. Schotman

Peter C. Schotman

Maastricht University - Department of Finance

Rolf Tschernig

University of Regensburg - Department of Economics and Econometrics; Maastricht University - Department of Quantitative Economics

Jan Budek

Maastricht University

Multiple version iconThere are 2 versions of this paper

Date Written: Fall 2008

Abstract

This paper explores the implications of asset return predictability for long-term portfolio choice when return-forecasting variables are fractionally integrated. For important predictor variables, like the dividend-price ratio, and nominal and real interest rates, we estimate orders of integration around 0.8. This leads to substantial increases of the estimated long-term risk of stocks, bonds, and cash compared to estimates obtained from a stationary VAR. Results are sensitive to the inclusion of the short-term nominal interest rate in the prediction equation of excess stock returns. Jointly with the dividend-price ratio it has significant predictive power, but contrary to the dividend-price ratio the nominal interest rate does not induce mitigating effects through mean reversion.

Keywords: G11, C32, long-term portfolio choice, linear processes with fractional integration, term structure of risk

Suggested Citation

Schotman, Peter C. and Tschernig, Rolf and Budek, Jan, Long Memory and the Term Structure of Risk (Fall 2008). Journal of Financial Econometrics, Vol. 6, Issue 4, pp. 459-495, 2008, Available at SSRN: https://ssrn.com/abstract=1281992 or http://dx.doi.org/10.1093/jjfinec/nbn010

Peter C. Schotman (Contact Author)

Maastricht University - Department of Finance ( email )

P.O. Box 616
Maastricht, 6200 MD
Netherlands
+31 43 388 3862 (Phone)
+31 43 388 4875 (Fax)

Rolf Tschernig

University of Regensburg - Department of Economics and Econometrics ( email )

Universitaetsstrasse 31
D-93040 Regensburg
Germany
+49 (0) 941 943 2737 (Phone)
+49 (0) 941 943 4917 (Fax)

HOME PAGE: www.wiwi.uni-regensburg.de/tschernig

Maastricht University - Department of Quantitative Economics ( email )

P.O. Box 616
Maastricht, 6200 MD
Netherlands

HOME PAGE: www.personeel.unimaas.nl/r.tschernig

Jan Budek

Maastricht University ( email )

P.O. Box 616
6200 MD Maastricht, 6200MD
Netherlands

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