What Moves Equity Markets? A Term Structure Decomposition for Stock Returns

Abstract

Several papers decompose stock returns into cash flow and discount rate news to study equity market fluctuations. This paper develops an alternative return decomposition based on the fact that equity movements originate from variation in the present values of dividends with different maturities. I find that roughly 60% of equity volatility comes from the present value of dividends with maturities beyond 20 years and that cash flow shocks drive volatility in short-term present values whereas discount rate news are responsible for volatility in long-term present values. I also provide three further empirical applications of this new equity term structure decomposition.

Keywords: Equity Volatility; Equity Term Structure; Equity Strips; Equity Duration; Campbell-Shiller

JEL Classification: E32, G10, G11, G12