Financial Integration and the Equity Term Structure: Insights from 150 Years of UK Data

We recover the term structure of equity risk premia in the UK from 1870 to 2019 and develop an international asset pricing model to interpret the results. Four main findings emerge. First, risk premia have declined markedly since the 1980s, particularly at short maturities, leading to a steeper equity term structure in the post-1980 period. Second, over the same time period, correlations in risk premia between the UK and the U.S. have risen substantially, particularly at short horizons. Third, viewed over the full 150-year sample, the equity term structure is upward-sloping on average, and investors demand higher compensation for bearing long-term than short-term equity risk. Fourth, the term structure flattens during periods of financial distress, driven by a disproportionate increase in short-term risk premia. Our international asset-pricing model attributes the post-1980 steepening of the term structure to greater financial integration, via enhanced cross-border diversification, which reduces short-term risk premia more than long-term premia.