Disaster Recovery and the Term Structure of Dividend Strips

Recent empirical findings document downward-sloping term-structures of equity volatil- ity and risk premia. An equilibrium model with rare disasters followed by recovery helps reconcile theory with empirical observations. While previous models focus on frequency and size of disasters, we show that recovery from disasters, a feature of the data, is at least as important. Indeed, recoveries outweigh the upward-sloping effect of time-varying disaster intensity, generating downward-sloping term-structures of div- idend risk, equity risk, and equity risk premia. The model quantitatively reconciles a high equity premium and a low risk-free rate with downward-sloping term-structures, which are at odds in standard frameworks.