Want to be notified when a new article is posted? Entere your email here.

Tuesday, October 27, 2009

Damodaran on the Equity Risk Premium

The Equity Risk Premium is one of the central concepts of finance theory and practice. However, when we teach it in class (usually as part of the CAPM), we tend to do a lot of hand-waving and tell students to use historical ERPs. Aswath Damodaran of New York University has an excellent piece on SSRN titled "Equity Risk Premiums: Determinants, Estimation, and Implications" that's a must-read whether you're a professor, student, or practitioner. Here's the abstract:
Equity risk premiums are a central component of every risk and return model in finance and are a key input into estimating costs of equity and capital in both corporate finance and valuation. Given their importance, it is surprising how haphazard the estimation of equity risk premiums remains in practice. In the standard approach to estimating equity risk premiums, historical returns are used, with the difference in annual returns on stocks versus bonds over a long time period comprising the expected risk premium. We note the limitations of this approach, even in markets like the United States, which have long periods of historical data available, and its complete failure in emerging markets, where the historical data tends to be limited and volatile. We look at two other approaches to estimating equity risk premiums - the survey approach, where investors and managers are asked to assess the risk premium and the implied approach, where a forward-looking estimate of the premium is estimated using either current equity prices or risk premiums in non-equity markets. We close the paper by examining why different approaches yield different values for the equity risk premium, and how to choose the "right" number to use in analysis. (In an addendum, we also look at equity risk premiums during the market crisis, starting on September 12, 2008 through October 16, 2008.)
Read the whole thing here.

2 comments:

Anonymous said...

My brother recommended I would possibly like this website.
He was once entirely right. This put up actually made my
day. You can not imagine simply how a lot time I had spent for this info!
Thank you!

my blog post - vigrx plus amazon

Anonymous said...

That is the proper blog for anybody who must look for out out concerning this
subject.
You realize a good deal its virtually arduous to argue along with you (not
that
I really would require...HaHa). You certainly put
a new spin on the topic thats been prepared about for many years.


Great stuff, simply excellent!

Feel free to visit my web page; six pack shortcuts workout plan pdf