Intermediary-Based Equity Term Structure

Abstract

We decompose the term structure of equity yields into an equity term premium and a mean reversion component about the expected changes in future yields to understand a seemingly contradictory evidence, that is, equity term premium is counter-cyclical, while the term structure slope of equity yields is pro-cyclical and even switches signs. Although the first component is counter-cyclical, we show the second component dominantly drives the pro-cyclical fluctuations of the overall equity yield curve. We propose a quantitative financial intermediary-based asset pricing model, in which the time-varying tightness of intermediaries' leverage constraint drives the mean reversion component.

Keywords: equity term structure, financial intermediary, mean reversion, discount rate

JEL Classification: E2, E3, G12