Correlated Cashflow Shocks, Asset Prices, and the Term Structure of Equity

39 Pages Posted: 2 Jun 2020 Last revised: 5 Oct 2021

See all articles by Michael Hasler

Michael Hasler

University of Texas at Dallas, Naveen Jindal School of Management, Department of Finance

Mariana Khapko

University of Toronto - Finance Area; Swedish House of Finance

Date Written: April 20, 2020

Abstract

The term structure of equity risk premium is moderately downward-sloping unconditionally,
markedly downward-sloping in good times, and markedly upward-sloping in bad times (Gormsen,
2021). An asset-pricing model featuring time-varying correlation between realized and expected
cashflow shocks explains these puzzling empirical findings. Indeed, the model-implied slope of
the equity term structure is in line with the data, both conditionally and unconditionally, because
the estimated cashflow shock correlation is volatile, counter-cyclical, and negative on average.
The model also generates realistic asset-pricing moments and a positive relation between the
equity risk premium, slope of the equity term structure, and the dividend yield.

Keywords: Correlated Cashflow Shocks, Equity Term Structure, Dividend Strips, Risk Premium, Volatility

JEL Classification: D51, D53, G12, G13

Suggested Citation

Hasler, Michael and Khapko, Mariana, Correlated Cashflow Shocks, Asset Prices, and the Term Structure of Equity (April 20, 2020). Available at SSRN: https://ssrn.com/abstract=3590248 or http://dx.doi.org/10.2139/ssrn.3590248

Michael Hasler (Contact Author)

University of Texas at Dallas, Naveen Jindal School of Management, Department of Finance ( email )

800 West Campbell
Richarson, TX 75080
United States

Mariana Khapko

University of Toronto - Finance Area ( email )

Toronto, Ontario M5S 3E6
Canada

Swedish House of Finance ( email )

Drottninggatan 98
Stockholm
Sweden

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