Long-run growth shocks steepen equity yield curve, ACDL model fits

The study empirically analyzes the response of equity yields to a total factor productivity (TFP) news shock, a well-identified long-run growth driver.

This shock significantly impacts consumption and aggregate dividends, which increase rapidly and then slowly converge to approximately 1% higher levels over five years.

Crucially, a positive TFP shock steepens the equity yield curve by increasing expected dividend growth, especially for short-term claims (e.g., over 1% for the 1-year claim).

Discount rates, however, remain largely unchanged.

This leads to a decline in the overall equity yield curve level but a steepening of its slope, with the 10-1 year equity yield slope rising by about 1% in the initial quarters.

These robust findings are consistent across alternative shocks, such as innovations in expected consumption growth, and are also observed using option-implied short-term equity yields.

The research evaluates four asset pricing models, including benchmark equity term structure models and the production-based general equilibrium model of Ai et al. (2018) (ACDL).

While all models predict higher expected growth from a shock, the ACDL model, when modified to separate cash dividends from total payout, best matches the empirical responses.

It correctly attributes the yield response to expected growth, unlike other models that either underestimate the effect or misassign it to the risk premium.

The study also investigates investment financing, revealing that aggregate cash and total payout respond oppositely to the long-run shock.

This indicates that new issuance, rather than reductions in cash payouts, primarily funds the increase in investment, establishing a strong negative correlation between investment and net repurchases.