The Role of Payout Horizon in Determining the Risks and Returns of Claims to Aggregate Cash Flows

This paper examines the implications of payout horizon for the prices of aggregate cashflows. The interaction of two long-run forces — a long-run risk in consumption and aggregate dividends, and a cointegration relationship between consumption and aggregate dividends — leads to non-monotonic relationships between a payout’s horizon and its cash flow risks, discount rate risks, and risk premia. These relationships with payout horizon are presented as term structures of risk sensitivities and return premia for so-called zero-coupon equity strips. Analytic expressions are derived for these term structures and examined to see how the interaction of long-run risk and cointegration determine risk and expected return. It is found that differences in payout horizon can result in significant differences in mean returns, with long-run strips earning the lowest risk premia and ‘intermediate’ term strips earning the highest premia. Based on this result, the paper then considers the possibility that differences in firms’ payout horizon can account for a value premium within this long-run risks framework. Significant differences in mean returns can arise. However, when payout horizon is the sole difference between firms, the model is unable to account for the failure of the CAPM when calibrated to match first and second moments of aggregate consumption, dividends, and the market. ∗The Wharton School, University of Pennsylvania, email: [email protected]. I thank Jessica Wachter and Amir Yaron for many helpful discussions. All mistakes are my own.