Download This PaperCorrelated Cashflow Shocks, Asset Prices, and the Term Structure of Equity
Management Science, Forthcoming
39 Pages Posted: 2 Jun 2020 Last revised: 9 Mar 2022
Date Written: April 20, 2020
Abstract
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 (Gormsen,
2021). 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.
Keywords: Correlated Cashflow Shocks, Equity Term Structure, Dividend Strips, Risk Premium, Volatility
JEL Classification: D51, D53, G12, G13
Suggested Citation: Suggested Citation
