Time Variation of the Equity Term Structure
65 Pages Posted: 21 Jun 2017 Last revised: 3 Oct 2019
Date Written: October 1, 2018
I document that the term structure of holding-period equity returns is counter-cyclical: it is downward sloping in good times, but upward sloping in bad times. The counter-cyclical 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, any one-factor model will fail to explain both the average downward slope and the counter-cyclical variation. I therefore introduce a new model with two priced risk factors to solve the puzzle.
Keywords: asset pricing, equity term structure, time varying discount rates
JEL Classification: G10, G12
Suggested Citation: Suggested Citation