Equity Risk Premium - How to Measure?

mit · April 9th, 2015, 6:58 am

I saw an equity strategy note, plotting a time series. The y-axis is 0% -10%. at the top range, it says "equities cheap relative to bond", bottom range reads "bonds cheap relative to equities".i wonder what are some ways to measure the equity risk premium, besides looking at historical returns and using a simple dividend discount model on this year's dividend.Thanks.

MrSmarT · April 9th, 2015, 3:45 pm

Greatly depends on the country you're in. But generally, it's a forward looking estimate. You can use the implied market return from an index for example. Or use historical. Then project the RfR going forward.It's much harder than it sounds, but that's the general idea.

mit · April 9th, 2015, 10:50 pm

can you point me to an example?

daveangel · April 10th, 2015, 7:12 am

QuoteOriginally posted by: mitcan you point me to an example?try searching for "equity risk premium damodaran" using the search engine of your choice (I recommend google).

mit · April 12th, 2015, 2:12 pm

damodaran things are for highschool

mit · April 13th, 2015, 2:27 pm

i found the SocGen methodology. It is actually similar to one of simple dividends with a few adjustments.I was looking for something more sophisticated.

sladner · April 14th, 2015, 11:58 am

if you find either a simple or sophisticated model which is good at forecasting equity returns relative to a rf rate on an out-of-sample basis, please let me know.

Alan · April 14th, 2015, 12:42 pm

QuoteOriginally posted by: miti found the SocGen methodology. It is actually similar to one of simple dividends with a few adjustments.I was looking for something more sophisticated.In theory, the equity risk premium should be quite sensitive to volatility. Extracting such dependence isnotoriously difficult for a variety of reasons and quite model dependent. Here is amethodology by Ait-Sahalia et al

DavidJN · April 14th, 2015, 3:43 pm

I was working on risk premiums implied in option prices a couple of decades ago and was metaphorically burned at the stake as heretic by some very narrow-minded people in Toronto. Stephen Ross and Peter Carr are two people who have been using similar tactics lately, look up their recent work.

mit · April 15th, 2015, 12:23 am

QuoteOriginally posted by: AlanQuoteOriginally posted by: miti found the SocGen methodology. It is actually similar to one of simple dividends with a few adjustments.I was looking for something more sophisticated.In theory, the equity risk premium should be quite sensitive to volatility. Extracting such dependence isnotoriously difficult for a variety of reasons and quite model dependent. Here is amethodology by Ait-Sahalia et althanks