Dynamic Equity Slope

Abstract

We develop a general equilibrium model that jointly explains important features of the term structure of equity: (i) a negative unconditional term premium, (ii) countercyclical term premia, (iii) procyclical equity yields, (iv) premia to value and growth claims respectively increasing and decreasing with the horizon. The economic mechanism hinges on the interaction between heteroskedastic long-run growth, which steers countercyclical risk premia, and homoskedastic short-term shocks in the presence of limited market participation, which generate sizeable short-term risk premia. The slope dynamics hold irrespective of the sign of its unconditional average. We provide empirical support to our model assumptions and predictions.

Keywords: term structure of equity, price dynamics, general equilibrium, expected growth volatility

JEL Classification: D51, D53, E30, G10, G12