Reinvestment Risk and the Equity Term Structure

118 Pages Posted: 6 Jun 2017 Last revised: 2 Dec 2020

See all articles by Andrei Gonçalves

Andrei Gonçalves

University of North Carolina (UNC) at Chapel Hill - Finance Area

Date Written: December 01, 2020

Abstract

The equity term structure is downward sloping at long maturities. I show, through an ICAPM estimation, that the tradeoff between market and reinvestment risk explains this pattern. Intuitively, while long-term dividend claims are highly exposed to market risk, they are also good hedges for reinvestment risk because dividend prices rise as expected returns decline, and longer-term claims are more sensitive to discount rates. In the estimated ICAPM, reinvestment risk dominates at long maturities, inducing relatively low risk premia on long-term dividend claims. The model is also consistent with the equity term structure cyclicality and the upward sloping bond term structure.

Keywords: Equity Term Structure, Reinvestment Risk, Intertemporal CAPM

JEL Classification: E32; E43; G11; G12

Suggested Citation

Gonçalves, Andrei, Reinvestment Risk and the Equity Term Structure (December 01, 2020). Fisher College of Business Working Paper No. 2017-03-014, Charles A. Dice Center Working Paper No. 2017-14, Kenan Institute of Private Enterprise Research Paper Forthcoming, Journal of Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2980925 or http://dx.doi.org/10.2139/ssrn.2980925

Andrei Gonçalves (Contact Author)

University of North Carolina (UNC) at Chapel Hill - Finance Area ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States

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