Reinvestment Risk and the Equity Term Structure
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
118 Pages Posted: 6 Jun 2017 Last revised: 2 Dec 2020
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: Suggested Citation