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The Term Structure of Returns: Facts and Theory

Last Updated on 10 February, 2024 by Rejaul Karim

Jules H. van Binsbergen and Ralph S. J. Koijen unravel the intricacies of equity dynamics in their comprehensive exploration, “The Term Structure of Returns: Facts and Theory,” spanning 48 enlightening pages. Within the realm of short-term equity claims, or dividend strips, a compelling revelation emerges—these claims boast notably higher returns than the overarching stock market.

The paradox deepens as the returns, while volatile, exhibit a safety measured by market beta. This departure from conventional macro-finance models prompts an exploration of innovative frameworks aligning with these empirical nuances. Beyond the confines of equity, the authors deftly connect the dots, drawing parallels with other asset classes like bonds, volatility, and housing.

In a grand finale, they weave the term structure of returns into the fabric of real economic decisions, offering a panoramic view that extends beyond financial markets. Van Binsbergen and Koijen’s synthesis reshapes our understanding of equity dynamics, urging us to reconsider traditional models in light of these revelatory facts.

Abstract Of Paper

We summarize and extend the new literature on the term structure of equity. Short-term equity claims, or dividend strips, have on average significantly higher returns than the aggregate stock market. The returns on short-term dividend claims are risky as measured by volatility, but safe as measured by market beta. These facts are hard to reconcile with traditional macro-finance models and we provide an overview of new models that can reproduce some of these facts. We relate our evidence on dividend strips to facts about other asset classes such as nominal and corporate bonds, volatility, and housing. We conclude by discussing the broader economic implications by linking the term structure of returns to real economic decisions such as hiring and investment.

Original paper – Download PDF

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Author

Jules H. van Binsbergen
University of Pennsylvania – The Wharton School; National Bureau of Economic Research (NBER)

Ralph S. J. Koijen
University of Chicago – Booth School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Conclusion

In conclusion, the investigation into the term structure of equity has revealed intriguing patterns that challenge traditional macro-finance models. The significant finding of higher returns on short-term equity claims, or dividend strips, introduces a nuanced dimension to risk and safety metrics.

These returns exhibit volatility but emerge as safe when measured by market beta, presenting a compelling puzzle for existing frameworks. The survey of contemporary models offers partial explanations for these phenomena, laying the foundation for further inquiries. Connecting the evidence to various asset classes broadens the scope, emphasizing the relevance of the term structure of returns across financial domains.

Finally, the discussion extends beyond the realm of finance, delving into the implications for real economic decisions, such as hiring and investment, underscoring the far-reaching impact of the term structure on broader economic dynamics.

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It Takes Two to Tango: Fundamental Timing in Stock Market

FAQ

Q1: What is the key revelation in Van Binsbergen and Koijen’s exploration of the term structure of equity returns?
A1: The study reveals that short-term equity claims, or dividend strips, exhibit notably higher returns than the aggregate stock market. This departure from conventional wisdom challenges traditional macro-finance models and introduces a nuanced dimension to risk and safety metrics.

Q2: How do the returns on short-term dividend claims differ in terms of volatility and safety, and what challenges do these findings pose to existing financial models?
A2: The returns on short-term dividend claims are volatile, but they emerge as safe when measured by market beta. This contradicts traditional macro-finance models, prompting the exploration of new frameworks that can better capture these empirical nuances.

Q3: Beyond equity, how does the study connect the term structure of returns to other asset classes, and what are the broader economic implications discussed in the paper?
A3: The study connects the evidence on dividend strips to other asset classes such as nominal and corporate bonds, volatility, and housing. The broader economic implications extend to real economic decisions like hiring and investment, emphasizing the far-reaching impact of the term structure of returns beyond financial markets.

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