The Factor Structure of Time-Varying Discount Rates
77 Pages Posted: 27 Nov 2015 Last revised: 27 Jul 2017
Date Written: June 1, 2017
Discount rate variation is driven by a short run business cycle component and a longer run trend component. This leads to state variable hedging of these two components and ICAPM logic implies a three factor model for expected returns. The factors represent cash ow news, short term discount rate news, and long term discount rate news. Both discount rate news components are important in describing the cross section of stock returns, and long run discount rate news commands a higher risk premium. Our results are consistent with any shape of the term structure of discount rates.
Keywords: Discount rates, risk factors, term structure of equity risk premium
JEL Classification: G12, G14
Suggested Citation: Suggested Citation