Bond and Stock Risk Premium Cycles: Implications for Asset Allocation

This paper examines the joint dynamics of equity and bond risk premia and their implications for asset allocation. Using long-term data on earnings yields and Treasury term premia, we document that both premia follow persistent, interacting cycles that define distinct market regimes. When the equity risk premium rises relative to the bond term premium, subsequent returns favor growth-sensitive assets; when the opposite occurs, duration exposure dominates. These cyclical interactions shape the time-varying diversification benefits of balanced portfolios and provide a practical framework for adjusting strategic and tactical allocations across asset classes. The results show that understanding the joint risk–premium cycle is essential for managing risk and opportunity within a multi-asset portfolio.