Can Reinvestment Risk Explain the Dividend and Bond Term Structures?
Charles A. Dice Center Working Paper No. 2017-14
105 Pages Posted: 6 Jun 2017 Last revised: 9 May 2019
Date Written: April 15, 2019
The term structure of dividend discount rates is downward sloping at long maturities despite the typical upward sloping bond yield curve. I empirically show that reinvestment risk explains both term structure patterns. Intuitively, dividend claims hedge reinvestment risk because dividend present values rise as expected returns decline. This hedge is better with longer-term claims given their higher sensitivity to discount rates, producing a downward sloping dividend term structure. In contrast, bonds are exposed to reinvestment risk because interest rates rise and bond prices fall as expected returns decline. This exposure increases with duration, generating an upward sloping bond term structure.
Keywords: Term Structure of Risk Premia; Reinvestment Risk; Intertemporal CAPM
JEL Classification: E32; E43; G11; G12
Suggested Citation: Suggested Citation