Term Structures of Equity and Interest Rates in Time-Varying Expected Growth Models

Abstract

Equilibrium asset-pricing models with time-varying expected economic growth have been criticized for their apparent inability to generate an upward-sloping yield curve and downward-sloping term structures of equity risk and risk premium. We theoretically investigate the model-implied equilibrium relationships between the shape of these term structures, the dynamics of economic fundamentals, and the representative agent's preferences. We show that this class of models is, in fact, flexible in its ability to reproduce the aforementioned shapes, while also generating realistic asset-pricing moments.