The Term Structures of Equity and Interest Rates / Martin Lettau, Jessica A. Wachter.

Format:

Book

Author/Creator:

Lettau, Martin.

Contributor:

National Bureau of Economic Research.

Wachter, Jessica A.

Series:

Working Paper Series (National Bureau of Economic Research) no. w14698.

NBER working paper series no. w14698

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2009.

Summary:

This paper proposes a dynamic risk-based model capable of jointly explaining the term structure of interest rates, returns on the aggregate market and the risk and return characteristics of value and growth stocks. Both the term structure of interest rates and returns on value and growth stocks convey information about how the representative investor values cash flows of different maturities. We model how the representative investor perceives risks of these cash flows by specifying a parsimonious stochastic discount factor for the economy. Shocks to dividend growth, the real interest rate, and expected inflation are priced, but shocks to the price of risk are not. Given reasonable assumptions for dividends and inflation, we show that the model can simultaneously account for the behavior of aggregate stock returns, an upward-sloping yield curve, the failure of the expectations hypothesis and the poor performance of the capital asset pricing model.

Notes:

Print version record

January 2009.