Production-Based Term Structure of Equity Returns

Abstract

We propose a unified general equilibrium production-based model to study the negative link between timing of cash flows and expected returns both in the cross section of stocks and along the aggregate equity term structure. Our economy incorporates long-run growth news and heterogenous exposure to aggregate productivity shocks across capital vintages, yielding a downward-sloping term structure, consistent with the empirical findings of Binsbergen et al. (2012). This result is preserved after the introduction of an endogenous stock of growth options that enables us to reproduce the empirical negative relationship between cash-flow duration and expected returns in the cross section of book-to-market-sorted stocks.