"Risk aversion heterogeneity and the equity term structure"

Abstract

"We explore the ability of a two-agent model with heterogeneous risk aversion to replicate key characteristics of the equity term structure. The model not only reproduces standard aggregate asset-pricing facts—such as procyclical interest rates and price–dividend ratios, and countercyclical stock volatility—but also several salient features specific to equity yields. In particular, it generates downward-sloping and countercyclical volatility, a downward-sloping equity yield curve during recessions, and countercyclical equity yield levels. Risk-aversion heterogeneity affects equity yields by shaping the stochastic discount factor and, consequently, the quantity of risk embedded in dividend strips. This mechanism is both state- and maturity-dependent: it is especially pronounced during recessions and for long-maturity claims. Overall, these findings highlight the central role of risk-aversion heterogeneity in understanding the behavior of the equity term structure. Copyright © 2026. Published by Elsevier Inc."