Term Structure(s) of the Equity Risk Premium

89 Pages Posted: 19 Mar 2018

See all articles by Leandro Gomes

Leandro Gomes

Gávea Investimentos

Ruy Ribeiro

Pontifical Catholic University of Rio de Janeiro (PUC-Rio) - Department of Economics; Itaú Asset Management

Date Written: March 19, 2018

Abstract

By simultaneously using dividend and variance swap data, we show how the term structure of the equity risk premium varies over time and how its shape is affected by liquidity risk premia. The term structure is always positively sloped, while funding liquidity premia and betas explain the high unconditional returns for all dividend claims. Alphas for short-dated dividend claims become negative, whereas alphas for long-dated claims seem to be positive. The term structure slope varies positively with the market risk premium, but it is never negative relative to the first contract – due to the nearly zero risk premium in the first maturity – and rarely hump-shaped in some empirical models. We demonstrate how the maturity term structure – the risk premium for dividend strips with different maturities – is connected to both the horizon term structure – linked to the variance swap term structure – and various funding liquidity measures. The risk premium is on average increasing with investment horizon, while the 𝑚𝑎𝑡𝑢𝑟𝑖𝑡𝑦 risk premium depends primarily on the short-horizon risk premium, implying that short-horizon investors are the marginal ones. All our results hold in the US, the UK, Europe and Japan. All these facts are consistent with, for instance, a long-run risk model with jump risks.

Keywords: Equity Risk Premium, Term Structure, Dividend Swaps, Variance Swaps, Liquidity

JEL Classification: G10, G12, G13, G23

Suggested Citation

Gomes, Leandro and Ribeiro, Ruy, Term Structure(s) of the Equity Risk Premium (March 19, 2018). Available at SSRN: https://ssrn.com/abstract=3144028 or http://dx.doi.org/10.2139/ssrn.3144028

Leandro Gomes

Gávea Investimentos ( email )

Rua Dias Ferreira, 190 7th andar
22431-050 Rio de Janeiro
Brazil

Ruy Ribeiro (Contact Author)

Pontifical Catholic University of Rio de Janeiro (PUC-Rio) - Department of Economics ( email )

Rua Marques de Sao Vicente, 225/206F
Rio de Janeiro, RJ 22453
Brazil

Itaú Asset Management ( email )

São Paulo
Brazil

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