The Equity Risk Premium
Author
Link
Cost
Paid
Published
2017
Full Name
The Equity Risk Premium: A Contextual Literature Review
The equity risk premium is the difference in expected or realized return between an equity index and a reference asset. It is widely acknowledged as the most important variable in finance. It is useful for knowing what returns to expect from each major asset class and from portfolios of securities or asset classes. It is also used in lifecycle and retirement planning and as a component of the opportunity cost of capital or required rate of return in corporate finance.
Research into this topic typically falls into three broad groupings:
- First, researchers have measured the margin by which equity total returns have exceeded fixed-income or cash returns over long historical periods and have projected this measure of the equity risk premium into the future.
- Second, the dividend discount model—or a variant of it, such as an earnings discount model—is used to estimate the future return on an equity index, and the fixed-income or cash yield is then subtracted to arrive at an equity risk premium expectation or forecast.
- Third, academics have used macroeconomic techniques to estimate what premium investors might rationally require for taking the risk of equities.