Equilibrium Predictability, Term Structure of Equity Premia, and Other Return Characteristics

Abstract

Abstract. This paper presents a structural model of aggregate return characteristics based on a one-channel Bansal and Yaron (2004) economy under recursive preferences. The results rest on an endogenously determined price-dividend ratio that is not exponentially affine which implies time variation and predictability of equity premia. The predictability coefficient is stochastic which provides theoretical foundations for recent works in predictability like Dangl and Halling (2011). In longer horizon, the predictability relationship is highly volatile making it difficult to make inference about long-horizon predictability.

Income Insurance and the Equilibrium Term Structure of Equity

“…V. The blue line denotes the sub-case Y t = X t (withμ = 2%, σ x = 1%, λ µ = .15, σ µ = 2%, β = 2.5%, γ s = 10, ψ = 2), which is similar to Hore (2015) and reproduces in continuous-time the main features of the standard long-run risk model of Bansal and Yaron (2004). In the right panel, the black lines (left axis) denote the polynomial fits of the variance ratios of the growth rates of net dividends (dot-dashed), after tax corporate profits (dashed).…”