Abstract
Levered noise occurs when no-arbitrage replication hedges fundamentals but amplifies price errors. Motivated by our theory, we use widely-available end-of-day OptionMetrics data to improve accuracy of synthetic dividend strip prices and provide longer samples than prior studies. Term structure point estimates are approximately flat in simple returns (88 bp/month vs. 87 bp/month for short-term dividends vs. index), and upward-sloping in measurement-error-robust logarithmic returns (43 bp/month vs. 77 bp/month). These results from prominent index options show the importance of diagnosing noise in no-arbitrage prices. Prior conclusions of an average downward slope in the equity term structure are not robust.
Original language | English (US) |
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Pages (from-to) | 1155-1182 |
Number of pages | 28 |
Journal | Review of Finance |
Volume | 27 |
Issue number | 4 |
DOIs | |
State | Published - Jul 1 2023 |
Keywords
- Dividend strips
- Equity risk premium
- Limits to arbitrage
- Microstructure frictions
- Term structure of equity risk premia
ASJC Scopus subject areas
- Accounting
- Finance
- Economics and Econometrics