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

Michael Hasler () and Mariana Khapko ()
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Michael Hasler: Jindal School of Management, University of Texas at Dallas, Richardson, Texas 75080
Mariana Khapko: Department of Management, University of Toronto Scarborough, Toronto, Ontario M1C 1A4, Canada; Rotman School of Management, University of Toronto, Toronto, Ontario M5S 3E6, Canada

Management Science, 2023, vol. 69, issue 9, 5560-5577

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. 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 (search for similar items in EconPapers)
Date: 2023
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Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:69:y:2023:i:9:p:5560-5577

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