Arbitrage Limits Cause Mispricing

Recent research on equities has found that, in contrast to classical economic theory, the term-structure of stock returns is downward-sloping. Stocks with low cash-flow duration earn higher returns than longer-duration stocks.

The duration of equities is defined as the weighted average time to maturity of cash flows. It comes from summing up discounted cash flows and comparing them to price. Stocks with a lot of cash flow in the near term have low duration, while stocks with low cash flow now, but that have a lot of prospective cash flow in the future, have high duration.

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