Term Structure of Equity Return Volatility

The term structure of equity return volatility fluctuates across time. It affects the term structure of equity returns through the volatility feedback effect and explains the cyclicality of equity return term structure. By analysing the dividend strip futures, this paper finds that volatility feedback effects of dividend strips exist and decrease with the horizon. Using realised and implied volatilities as business cycle indicators, this paper confirms that the term structure of equity returns is pro-cyclical. Decomposition of cyclicality shows that the pro-cyclical term structure of equity returns comes from the high relative sensitivity of short-duration volatility. The predictability of cyclicality by the term structure of volatility is a novel feature that can be used to test macro-finance models. The rare disaster model proposed by Gabaix (2012) is rejected by the test