Asset pricing with horizon-dependent risk aversion

We study general equilibrium asset prices in a multi-period endowment economy when agents' risk aversion is allowed to depend on the maturity of the risk. We find horizon-dependent riskaversion preferences generate a decreasing term structure of risk premia if and only if volatility is stochastic. Our model can thus justify the recent empirical results on the term structure of risk premia if the pricing of volatility risk is downward sloping (in absolute value) in the data and if downward-sloping term structures of returns on a given market are driven solely by exposures to volatility risk. We test these predictions by estimating the price of volatility risk using index options data and by showing that the value premium is related to the exposure to volatility risk.