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implied equity risk premium
Posted: August 24th, 2006, 6:43 pm
by RedSniper
Hello:Is it possible to derive an implied equity risk premium from (derivatives) prices, e.g. equity swaps? Any references on this?
implied equity risk premium
Posted: August 25th, 2006, 7:41 pm
by bskilton81
Doesn't Black Litterman attempt to do this via reverse optimization? I thought it took market cap weights as optimized weights and then used the cov matrix and the weights to derive the implied expected returns. Obviously, then your equity risk premium would just be the expected equity return less the risk free rate. Note sure abou this however.
implied equity risk premium
Posted: August 26th, 2006, 5:35 am
by gjlipman
My first thought is that a complete market will only let you imply a risk neutral distribution and expectation of a share price, not a real world expectation (that you'd need to imply the erp), but have to admit I'm not up on Black Litterman. Not that it is a proof, but I can't imagine there would have been the same debate on the ERP if it had been possible to imply the right answer.