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The Term Structure of Equity Risk Premia: Levered Noise and New Estimates

Author

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  • Oliver Boguth
  • Murray Carlson
  • Adlai Fisher
  • Mikhail Simutin

Abstract

Levered noise occurs when no-arbitrage replication hedges fundamentals but amplifies price errors. Motivated by our theory, we use widely-available end-of-day OptionMetrics data to improve accuracy of synthetic dividend strip prices and provide longer samples than prior studies. Term structure point estimates are approximately flat in simple returns (88 bp/month vs. 87 bp/month for short-term dividends vs. index), and upward-sloping in measurement-error-robust logarithmic returns (43 bp/month vs. 77 bp/month). These results from prominent index options show the importance of diagnosing noise in no-arbitrage prices. Prior conclusions of an average downward slope in the equity term structure are not robust.

Suggested Citation

  • Oliver Boguth & Murray Carlson & Adlai Fisher & Mikhail Simutin, 2023. "The Term Structure of Equity Risk Premia: Levered Noise and New Estimates," Review of Finance, European Finance Association, vol. 27(4), pages 1155-1182.
    • Handle: RePEc:oup:revfin:v:27:y:2023:i:4:p:1155-1182.
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    More about this item

    Keywords

    Equity risk premium; Dividend strips; Term structure of equity risk premia; Limits to arbitrage; Microstructure frictions;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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