Equity risk premiums across horizons and their link to inflation: A quadratic Gaussian approach

We develop a framework based on a quadratic Gaussian asset pricing model to analyze the term structure of the equity risk premium (ERP) in a lower-bound interest-rate environment. To address the analytical intractability of the expected dividend growth component of the ERP in this nonlinear setting, we derive an approximate analytical expression and validate it against simulation results. This approach enables efficient evaluation of ERPs across different horizons and supports a deeper exploration of their relationship with inflation dynamics. Empirical analysis of U.S. financial time series data since 2000 shows that the trend and volatility components of inflation dynamics relate to ERPs differently across horizons. In particular, short-horizon ERPs are more closely associated with inflation volatility, whereas long-horizon ERPs are more strongly related to the inflation trend. Since 2020, short- and long-horizon ERPs have exhibited distinctive patterns not observed in the previous two decades, with these movements linked primarily to changes in inflation-trend factors.