Dynamic Equity Slope

Abstract

This paper empirically documents that expected growth volatility is a key driver of the equity term structure dynamics. A general equilibrium model jointly explains four important patterns: (i) a potentially negative unconditional equity term premium, (ii) countercyclical equity term premia, (iii) procyclical equity yields, and (iv) premia to value and growth claims respectively increasing and flat with the horizon. The economic mechanism hinges on the interaction between heteroscedastic long-run growth, which leads to countercyclical risk premia, and homoscedastic short-term shocks under limited market participation, which produce sizable risk premia to short-term cash flows. The equity slope dynamics hold irrespective of the sign of its unconditional average.

Keywords: Term Structure of Equity, Dynamics, General Equilibrium, Expected Growth Volatility

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