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Term Structure of Recession Probabilities and the Cross Section of Asset Returns

Business cycle duration changes over time, generating time-varying investor concern over future recessions. This paper introduces ex-ante measures of recession concern based on term structure of recession probability forecasts by the Survey of Professional Forecasters. The slope of the recession term structure is negatively priced in a wide range of assets, and negatively predicts economic activity and labor income growth. A belief-augmented CAPM with the market factor and innovation to the slope largely explains size, book-to-market, and asset growth-sorted portfolios. This model's factor-mimicking portfolios also help reconcile index options and carry trade strategies. My evidence suggests that the slope of the term structure is a recession state variable of special hedging concern (Cochrane, 2005, Ch.9), and an important source of asset premia can be attributed to exposure to investors' recession concern that is priced.