Term Structure Of Equity Research Articles

The term structure of equity yields—a bottom-up approach

Abstract This article proposes a novel perspective on the term structure of market equity yields. Instead of using market dividend futures, we aggregate equity yields of individual firms to estimate the market equity yield curve. This approach allows studying the aggregation effect that shapes the market equity yield curve. During the period from 1990 to 2019, we find a positive aggregation effect: companies with high equity yields were expected to grow at higher rates than companies with low equity yields. Thus, high-yield companies were expected to generate an increasing share of total market dividends when expanding the investment time horizon. Under the assumption of flat firm-risk premia, this implies an upward-sloping term structure of equity risk premia. Together with the concave bond yield curve, the market equity yield curve was upward-sloping.

The Equity Term Structure in Equilibrium Model

The Equity Term Structure in Equilibrium Model

Does Heterogeneity in Risk Aversion Imply a Downward-Sloping Equity Term Structure?

Does Heterogeneity in Risk Aversion Imply a Downward-Sloping Equity Term Structure?

Correlated Cashflow Shocks, Asset Prices, and the Term Structure of Equity

The term structure of equity risk premium is moderately downward-sloping unconditionally, markedly downward-sloping in good times, and markedly upward-sloping in bad times. An asset-pricing model featuring time-varying correlation between realized and expected cashflow shocks explains these puzzling empirical findings. Indeed, the model-implied slope of the equity term structure is in line with the data, both conditionally and unconditionally, because the estimated cashflow shock correlation is volatile, counter-cyclical, and negative on average. The model also generates realistic asset-pricing moments and a positive relation between the equity risk premium, slope of the equity term structure, and the dividend yield. This paper was accepted by David Sraer, finance. Funding: The authors thank the University of Texas at Dallas and the University of Toronto for financial support. Supplemental Material: The data files are available at https://doi.org/10.1287/mnsc.2022.4565 .

The Term Structure of Equity Risk Premia: Levered Noise and New Estimates

Abstract Levered noise occurs when no-arbitrage replication hedges fundamentals but amplifies price errors. Motivated by our theory, we use widely-available end-of-day OptionMetrics data to improve accuracy of synthetic dividend strip prices and provide longer samples than prior studies. Term structure point estimates are approximately flat in simple returns (88 bp/month vs. 87 bp/month for short-term dividends vs. index), and upward-sloping in measurement-error-robust logarithmic returns (43 bp/month vs. 77 bp/month). These results from prominent index options show the importance of diagnosing noise in no-arbitrage prices. Prior conclusions of an average downward slope in the equity term structure are not robust.

Horizon Bias and the Term Structure of Equity Returns

AbstractWe label the degree to which individuals are more optimistic at long horizons relative to short horizons as the horizon bias. We examine whether time-series variation in the horizon bias can explain the time-series variation in the equity term structure. We use analyst earnings forecasts to measure the degree of the horizon bias in the stock market. Consistent with the intuition from a stylized present value model, we find that periods of above-average horizon bias are associated with negative term premiums, whereas periods of below-average horizon bias are associated with positive term premiums.Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

The Price of Uncertainty in the Term Structure of Equity and Treasury Yields

The Price of Uncertainty in the Term Structure of Equity and Treasury Yields

Time-Varying Risk Aversion and the Equity Term Structure

Time-Varying Risk Aversion and the Equity Term Structure

Does the Term-Structure of Equity At-the-Money Skew Really Follow a Power Law?

Does the Term-Structure of Equity At-the-Money Skew Really Follow a Power Law?

The term structure of equity risk premia

We estimate a regime-switching model for the equity term structure with Bayesian methods. Our approach accounts for the data sample being unrepresentative of the population distribution of regimes. We find that (i) the term structure of expected equity dividend strip returns is downward sloping in recessions and upward sloping in expansions, and (ii) the unconditional term structure of expected equity returns is positively sloped. Our estimation shows that the sample unrepresentativeness induces a downward bias in the estimate of the equity term structure slope. We present a regime-switching consumption-based asset-pricing model that matches the empirical findings.

Dissecting Macroeconomic News

AbstractHow do macroeconomic events affect the term structure of equity returns? We document that the term structure of equity excess returns is upward sloping on federal fund rate announcement days but not on nonannouncement days. The dividend strips respond significantly to macroeconomic news and the strength of the announcement response declines with the maturity of the dividend asset. Our analysis reveals that nonfarm payrolls surprises have the largest impact on the term structure of dividend strips. The cash flow and discount rate channels both contribute to the response of the dividend asset to macroeconomic news.

Reinvestment Risk and the Equity Term Structure

ABSTRACTThe equity term structure is downward sloping at long maturities. I estimate an Intertemporal Capital Asset Pricing Model (ICAPM) to show that the trade‐off between market and reinvestment risk explains this pattern. Intuitively, while long‐term dividend claims are highly exposed to market risk, they are good hedges for reinvestment risk because dividend prices rise as expected returns decline, and longer‐term claims are more sensitive to discount rates. In the estimated ICAPM, reinvestment risk dominates at long maturities, inducing relatively low risk premia on long‐term dividend claims. The model is also consistent with the equity term structure cyclicality and the upward‐sloping bond term structure.

Time Variation of the Equity Term Structure

ABSTRACTI study the term structure of one‐period expected returns on dividend claims with different maturity. I find that the slope of the term structure is countercyclical. The countercyclical variation is consistent with theories of long‐run risk and habit, but these theories cannot explain the average downward slope. At the same time, the cyclical variation is inconsistent with recent models constructed to match the average downward slope. More generally, the average and cyclicality of the slope are hard to reconcile with models with a single risk factor. I introduce a model with two priced factors to solve the puzzle.

The Implied Equity Term Structure

We propose a new methodology to estimate the equity term structure, based on the cross-section of stock prices and the implied cost of capital approach. Specifically, instead of focusing on the realized returns of maturity-specific dividend assets, we imply the term structure of expected returns based on the observed market prices and projected firm-level cash flows. Using US data for 1976-2019, we find an unconditionally upward sloping term structure of risk premia with rich cross-sectional patterns. Namely, large and growth firms exhibit an upward sloping term structure, whereas the smallest and value firms mostly have a downward sloping term structure. We also detect that the slope of the term structure changes from negative to positive in the late 1990s for the largest firms, as well as that the slope tends to flatten out or even invert in recessions. Thus, using a direct measure of ex-ante returns, we are able to provide new evidence on the debated properties of the equity term structure.

Term Structure of Equity and Bond Yields over Business Cycles

Recent findings on the term structure of equity and bond yields pose serious challenges to existing equilibrium asset pricing models. This paper presents a new equilibrium model of subjective expectations to explain the joint historical dynamics of equity and bond yields (and their yield spreads). Equity/bond yields movements are mainly driven by subjective dividend/GDP growth expectations. Yields on short-term dividend claims are more volatile because short-term dividend growth expectation mean-reverts to its less volatile long-run counterpart. Procyclical slope of equity yields is due to the counter-cyclical slope of dividend growth expectations. The correlation between equity returns/yields and nominal bond returns/yields switched from positive to negative after the late 1990s, mainly owing to a stronger correlation between real GDP growth and real dividend growth expectations, and only partially due to procyclical inflation. Dividend strip returns are predictable and the strength of predictability decreases with maturity due to predictable dividend forecast errors and revisions. The model is also consistent with the data in generating persistent and volatile price-dividend ratios, and excess return volatility.

Monetary Policy and the Equity Term Structure

We study the impact of monetary policy on the term structure of equity prices. We find that short-term and long-term equity prices respond in opposite ways to changes in monetary policy. Following an unanticipated cut in the target federal funds rate, short-term equity prices fall while long-term equity prices rise on average. This pattern could arise if policy decisions signal information about economic conditions. We examine this mechanism and find that the price change of the short-term equity asset in the 30-minute window around an FOMC announcement significantly predicts both macroeconomic growth and professional forecast errors over subsequent quarters.

Corporate Policies and the Term Structure of Risk

We build a dynamic corporate finance model with heterogeneity in the pricing and in the firm's exposure to aggregate risks. All else equal, we show that if long-term (persistent) shocks have a higher market price than short-term (temporary) shocks, firms shorten the horizon of corporate policies, favoring payouts over investment. In the cross section, this effect is stronger for firms more exposed to long-term shocks, but can be reversed for firms more exposed to short-term shocks. Our analysis is extended to embed time variation in risk prices over the business cycle, motivated by recent evidence on the term structure of equity.

Cash-flow Risk and Industry Response to COVID-19 Outbreak

I use the exogenous shock to aggregate consumption caused by the COVID-19 pandemic to examine the importance of cash-flow risk for investors. I find that the industry long-run cash-flow risk predicted which industries performed worst during the pandemic. High cash-flow risk industries experienced abnormally low excess returns and substantially higher risk levels during the first three months of 2020. I use dividend futures data to show that the equity term structure inverted and forward equity yields proliferated after mid-March 2020, which may explain the heightened relevance of cash-flow risk during the pandemic.

The term structure of equity and variance risk premia

We study the term structure of variance swaps, equity and variance risk premia. A model-free analysis reveals a significant price jump component in variance swaps. A model-based analysis shows that investors’ willingness to ensure against volatility risk increases after a market drop. This effect is stronger for short maturities, but more persistent for long maturities. During the financial crisis investors demanded large risk premia to hold equities, but the risk premia largely depended on and strongly decreased with the holding horizon. The term structure of equity and variance risk premia responds differently to various economic indicators.

Dynamic Equity Slope

The term structure of equity and its cyclicality are key to understand the risks driving equilibrium asset prices. We propose a general equilibrium model that jointly explains four important features of the term structure of equity: (i) a negative unconditional term premium, (ii) countercyclical term premia, (iii) procyclical equity yields, and (iv) premia to value and growth claims respectively increasing and decreasing with the horizon. The economic mechanism hinges on the interaction between heteroskedastic long-run growth – which helps price long-term cash flows and leads to countercyclical risk premia – and homoskedastic short-term shocks in the presence of limited market participation – which produce sizeable risk premia to short-term cash flows. The slope dynamics hold irrespective of the sign of its unconditional average. We provide empirical support to our model assumptions and predictions.