On the Riskiness of Stocks Over the Long Run: Asset-Pricing Perspectives

Abstract

We study the riskiness of stocks over long horizons from the perspectives of Bayesian investors who employ economic theory, specifically prospect theory or long-run risk, to form prior beliefs about return dynamics. Over long horizons, per-period volatility could be lower due to mean reversion or higher because of uncertainty about expected returns and estimation risk. Model-based priors typically reduce parameter uncertainty. Moreover, prospect-theory investors perceive safer stocks due to considerable mean reversion whereas long-run-risk investors perceive riskier stocks due to weak mean reversion. Economic theory delivers important guidance about long-horizon investment opportunities as the sample evidence is relatively uninformative.