A model for pricing stocks and bonds

H Mamaysky - Available at SSRN 307203, 2002 - papers.ssrn.com
Available at SSRN 307203, 2002papers.ssrn.com
This paper develops a tractable, dynamic, arbitrage-free model capable of jointly pricing a
cross section of bonds and stocks. The bond pricing portion of the model produces the
standard affine term-structure equations. It is then shown that a particular choice of dividend
process, characterized by affine dividend yields, leads to stock prices that are exponential
affine in the model's state variables. Importantly, the model allows for quite general
interdependence between bond and stock prices. The paper also shows that an alternative …
Abstract
This paper develops a tractable, dynamic, arbitrage-free model capable of jointly pricing a cross section of bonds and stocks. The bond pricing portion of the model produces the standard affine term-structure equations. It is then shown that a particular choice of dividend process, characterized by affine dividend yields, leads to stock prices that are exponential affine in the model's state variables. Importantly, the model allows for quite general interdependence between bond and stock prices. The paper also shows that an alternative modeling strategy for dividends, characterized by affine dividend growth rates, produces a less tractable model than the affine yield approach.
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