Can Reinvestment Risk Explain the Dividend and Bond Term Structures?

Fisher College of Business Working Paper No. 2017-03-014

Charles A. Dice Center Working Paper No. 2017-14

105 Pages Posted: 6 Jun 2017 Last revised: 9 May 2019

See all articles by Andrei Gonçalves

Andrei Gonçalves

University of North Carolina (UNC) at Chapel Hill - Finance Area

Date Written: April 15, 2019

Abstract

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

Gonçalves, Andrei, Can Reinvestment Risk Explain the Dividend and Bond Term Structures? (April 15, 2019). Fisher College of Business Working Paper No. 2017-03-014; Charles A. Dice Center Working Paper No. 2017-14. Available at SSRN: https://ssrn.com/abstract=2980925 or http://dx.doi.org/10.2139/ssrn.2980925

Andrei Gonçalves (Contact Author)

University of North Carolina (UNC) at Chapel Hill - Finance Area ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States

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