The term structure of equity premia in an affine arbitrage-free model of bond and stock market dynamics

We estimate time-varying expected excess returns on the US stock market from 1983to 2008 using a model that jointly captures the arbitrage-free dynamics of stockreturns and nominal bond yields. The model nests the class of affine term structure (ofinterest rates) models. Stock returns and bond yields as well as risk premia are affinefunctions of the state variables: the dividend yield, two factors driving the one-periodreal interest rate and the rate of inflation. The model provides for each month the`term structure of equity premia', i.e. expected excess stock returns over variousinvestment horizons. Model-implied equity premia decrease...