Term Structure of Equity Return Volatility

38 Pages Posted: 20 Oct 2022

See all articles by Wentao Li

Wentao Li

Saïd Business School, University of Oxford

Date Written: April 27, 2022

Abstract

The term structure of equity return volatility fluctuates across time. It affects the term structure of equity returns through the volatility feedback effect and explains the cyclicality of equity return term structure. By analysing the dividend strip futures, this paper finds that volatility feedback effects of dividend strips exist and decrease with the horizon. Using realised and implied volatilities as business cycle indicators, this paper confirms that the term structure of equity returns is pro-cyclical. Decomposition of cyclicality shows that the pro-cyclical term structure of equity returns comes from the high relative sensitivity of short-duration volatility. The predictability of cyclicality by the term structure of volatility is a novel feature that can be used to test macro-finance models. The rare disaster model proposed by Gabaix (2012) is rejected by the test.

Keywords: Term Structure of Equity Returns, Volatility, Return Prediction

JEL Classification: G12, G13, G17

Suggested Citation

Li, Wentao, Term Structure of Equity Return Volatility (April 27, 2022). Available at SSRN: https://ssrn.com/abstract=4251820 or http://dx.doi.org/10.2139/ssrn.4251820

Wentao Li (Contact Author)

Saïd Business School, University of Oxford ( email )

Park End Street
Oxford, OX1 1HP
Great Britain

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