Production-Based Term Structure of Equity Returns

We study the link between timing of cash flows and expected returns in general equilibrium production economies. Standard neoclassical RBC models produce an upward-sloping term structure of equity returns. Our economy incorporates heterogeneous exposure to aggregate productivity shocks across capital vintages, yielding a downward-sloping term structure over a ten-year horizon, consistent with the empirical findings of Binsbergen et al. (2012a, b). This result is preserved after the introduction of an endogenous stock of growth options that enables us to reproduce the empirical negative relationship between cash-flow duration and expected returns in the cross section of book-to-market sorted stocks.