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Equity Yields University of Pennsylvania ScholarlyCommons Finance Papers Wharton Faculty Research 12-2013 Equity Yields Jules van Binsbergen University of Pennsylvania Wouter Hueskes Ralph Koijen Evert Vrugt Follow this and additional works at: https://repository.upenn.edu/fnce_papers Part of the Finance Commons, and the Finance and Financial Management Commons Recommended Citation van Binsbergen, J., Hueskes, W., Koijen, R., & Vrugt, E. (2013). Equity Yields. Journal of Financial Economics, 110 (3), 503-519. http://dx.doi.org/10.1016/j.jfineco.2013.08.017 At the time of publication, author Jules van Binsbergen was affiliated with Stanford University and Tilburg University, The Netherlands. Currently, he is a faculty member at the Wharton School at the University of Pennsylvania. This paper is posted at ScholarlyCommons. https://repository.upenn.edu/fnce_papers/379 For more information, please contact [email protected]. Equity Yields Abstract We study a new data set of dividend futures with maturities up to ten years across three world regions: the US, Europe, and Japan. We use these asset prices to construct equity yields, analogous to bond yields. We decompose the equity yields to obtain a term structure of expected dividend growth rates and a term structure of risk premia, which decomposes the equity risk premium by maturity. We find that the slope of the term structure of risk premia is pro-cyclical, whereas the slope of the term structure of expected dividend growth rates is counter-cyclical. The comovement of yields across regions is, on average, higher for long-maturity yields than for short-maturity yields, whereas the variation in this comovement is much higher for short-maturity yields. Disciplines Finance | Finance and Financial Management Comments At the time of publication, author Jules van Binsbergen was affiliated with Stanford University and Tilburg University, The Netherlands. Currently, he is a faculty member at the Wharton School at the University of Pennsylvania. This journal article is available at ScholarlyCommons: https://repository.upenn.edu/fnce_papers/379 Equity Yields* Jules H. van Binsbergen·i· Wouter H . Hueskes+ Ralph S.J. Koijen§ Northwestern Kellogg APG Asset Management Chicago Dooth and Stanford GSD and NDER. and NDE R. Evert B. Vrugt,. VU University' Amsterdam This version: :rvlarch 2012 Abstract vVe study a new data set of dividend derivatives wit h mat urities up to 10 years across three world regions: the US, Europe, and Japa n. \Ve use these a..9set pricPA9 to construct equity yields, analogous to bond yields. \Ve de­ compose the equity yields to obtain a term struct ure of expected dividend gro·wth rates and a term struct ure of risk premia, which decomposes the equity risk premium by ma turity. \Ve find that t he slope of the term st ruc­ ture of risk premia is pro-cyclical, \vhereas t he slope of t he term st ructure of expected dividend growth rates is counter-cyclical. T he comovement of yields across regions is on average higher for long-ma turity yields t han for short-maturity yields, where.as the variation in this com ovement is much higher for short-mat urity yields. *This paper was previously circulated as: "A Term St ructure of Growth." \Ve thank .J erome Dominge and Sander va n Zelm at B)TP Par iha.<; and C hristian :Viueller-G lissma nn at G oldman Sachs International for providing us wit h t he d at a. \Ve are grat eful to ::\Iichael Br andt, J ohn CampbelL John Cochrane, George Constantinides, Darrell Duffie, Lars Hansen, J ohn Heaton, Anil Kashyap, Bryan K elly, Martin Lettau, Syd ney Lud vigson, Hanno Lustig, Ian :\iart in, Emi )faka.mura, Dimitris Papanikola.ou, J onathan Parker, :\Ionika. Piazzesi, Ana.rnaria Piescha.con , Sergio Rebelo, :\-Iartin Schneider, Ken Singlet on, .Jon Steinsson , Cost is Skia<lis, Stijn Van )fieuwerhurgh, Annett e V issing-.Jorgensen, and seminar part icipants at APG , C:\IU, Chicago Booth, t he 2011 EFA meetings, HKUST, K ellogg, I)TSEAD, :\JcGill University, ::\Idntire School of Commerce, the :\iinneapolis Fe<l, )TT U, )[US, R.S:\J, SED meetings, Stanfor d, SITE 2011, S:\IU, SIFR., T ilb urg, Ut a h, University of :\Jinneapolis, University of Sydney, and Yale for comments. tj-vanhinshergen1~kellogg.northwestern . edu , (847) 4D1- :J8:.~8 , http:/ / www .s-t.a nfonl.e<lu/ jv b2/ +wouter. hueskes(~apg- am.nl, +:n (0) 20 604 8:JOD §ral ph.koijen1khicagol>oot h.edu, (7n) 8~~4-41D D, ht tp:/ /fa.cult.y.chicagohoot h.e<ln/ ra.lph.koijen/ , evrugi .Xhs4all.nl, http:/ jwww .evertvrugi .. com. VD University Amsi .en lam, PG0 -1:\<1, De Boelelaan 11();) , 1081 HV Amst erdam, The )fetherlaiHi<; There e..xists a large literature studying fluctuations of, and the information contained m, the term structures of nominal and real interest rates. 1 At each point in time, t hese term structures smmnari:te pricing information of either nominal or real claims ·with dif­ ferent maturities. In this paper, vve study a novel term structure of a...;;sets that are direct claims to future dividends paid by firms to shareholders. Our dat a set is available at a daily frequency with maturities up to 10 years, with 1-year increments. Dased on these dividend a...;;sets, we construct a term structure of equity yields that are a nalogous to real and nominal bond yields. T he key difference between dividend asset s and either nominal or real bonds is that the final payoff of dividend assets is variable whereas the payoff of nominal and real bonds is fixed in nominal a nd re-al terms, respectively. In t his paper, \ve explore the information contained in equity yields across three major equity markets: the US, Europe, and .Japan. The equity yield at time t with maturity n can be written a..s t he sum of t hree com­ ponents. It consists of the nominal bond yield with maturity n , plus a maturity-specific risk premium that inveBtors require for holding dividend risk, minus the expected divi­ dend growt h ra te, which represents the average expected dividend growth over the next n periods. Iligher discounting increa..ses the yield, wherea..s higher expected dividend grmvth lowers t he yield.2 Dividend a..ssets, also called dividend strips, are generally t raded in fut ures or swap markets, not in spot markets. Spot prices and futures prices are linked through bond priceB. Assuming no-arbitrage, we can replace spot prices 'vith futures prices in our computations to obtain forward equity yields, denoted by e{n, which do not depend on then-year bond yield. The fo rward equity yield is simply equal to t he difference between the maturity-specific dividend risk premium, which we denote by Bt,n, and the average n-year expected dividend growth rate 9t,n : f et.n fhn '-V.,/ ~ ~ (1) n-yC'..a r for ward equity yield risk premium expected dividend growth This implies that, by definition, forward equity yields must either predict dividend growth rates or excess returns (in excess of bonds) on dividend assets, or both. A high (low) value of the forward equity yield implieB that t he risk premium is high (low) or that the e..xpected 1See Singlet on (1980), Singleton (198:3), Fama and Bliss (1987), Piazzesi (2001), Ang aml Piazzesi (2003), Ang a nd Monika Piazzesi (2006), Cochrane and Piazzesi (2005), Ludvigson and Ng (2009), Duffee (2011), among many others. 2There is a straightforward analogy with nominal and real bond yield. T he difference between nominal and r t>.al bond yields is expected inflation and the inflation risk premium. Similarly, the difference between equity yields and nominal homl yiel&:; is expeeted dividend growth aml t he dividerul risk pr emium. 1 dividend gro-wth rate is lmv (high). This makeB forward equity yields natural candidateB to forecast dividend grmvt h across various maturitieB. \Ve find that forward equity yields fluctuate st rongly over time, for all maturities, and for all geographic regions. T hese fluc­ tuations are due to both expected dividend growth variation and risk premium variation. Particularly during t he great recession, 1-year forward equity yields turn strongly positive \vith values above :30% for the US, and values above 50% for Europe a nd Japan. \Ve find tha t for all regions, expected dividend growth rates were low (negative) and risk premia were high during this period . This paper is the first to compute and analy~e t he behavior of the term structure of equity yields. Our new data set allows us to make two important additional contributions to the a.<>set pricing literat ure. First, risk pricing across maturitiPB h a.<> recent ly received a lot of attention. Important contributions in t his literature are Lettau and \Vachter (2007) and Ilansen , Ileaton , and Li (2008). In a recent paper, Dinsbergen , Drandt, and Koijen (2011) show that, unconditionally, risk premia are high for short-maturity dividend strips, which seems pu~ ~ling for several leading a.<>set pricing models. In t his paper, we study the time variation in risk pricing (risk premia) across maturities. \Ve find t hat the slope of t he term structure of the dividend risk premium moves in a strongly pro-cyclical fashion. That is, long-maturity risk premia are higher than short-maturity risk premia during expansions and lmver during recessions. The opposite holds for the slope of the term structure of expected dividend grmvth rates, which moves in a strongly counter­ cyclical fashion. Further, t he volatility of risk premia is decre..asing \vith maturity. lienee, our paper contributes to a large litera t ure documenting tha t the equity risk premium fluctuates over time.
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