The Equity Risk Premium in 2012

22 Pages Posted: 13 Mar 2012

See all articles by John R. Graham

John R. Graham

Duke University; National Bureau of Economic Research (NBER)

Campbell R. Harvey

Duke University - Fuqua School of Business; National Bureau of Economic Research (NBER)

Date Written: March 11, 2012

Abstract

We analyze the history of the equity risk premium from surveys of U.S. Chief Financial Officers (CFOs) conducted every quarter from June 2000 to March 2012. The risk premium is the expected 10-year S&P 500 return relative to a 10-year U.S. Treasury bond yield. While the risk premium sharply increased during the financial crisis peaking in February 2009, the premium steadily fell until the second quarter 2010. The current surveys show that the premium has increased to near to the levels during the financial crisis. The survey also provides measures of cross-sectional disagreement about the risk premium, skewness, and a measure of individual uncertainty. We find that dispersion of beliefs is above average as well as individual uncertainty. We find little relation between our survey-based risk premium and a measure of the implied cost of capital that relies on individual firms’ forecasted future cash flows. We also present evidence on the determinants of the long-run risk premium. Our analysis suggests the level of the risk premium closely tracks both market volatility (reflected in the VIX index) as well as credit spreads. However, the most recent data show a puzzling divergence between VIX and our measure of the risk premium. Our analysis suggests that market volatility is inexplicably low.

Keywords: Cost of capital, financial crisis, equity premium, long-term market returns, long-term equity returns, expected excess returns, disagreement, individual uncertainty, skewness, asymmetry, survey methods, risk and reward, TIPs, VIX, Credit spreads, Implied cost of capital

JEL Classification: G11, G31, G12, G14

Suggested Citation

Graham, John Robert and Harvey, Campbell R., The Equity Risk Premium in 2012 (March 11, 2012). Available at SSRN: https://ssrn.com/abstract=2020091 or http://dx.doi.org/10.2139/ssrn.2020091

John Robert Graham

Duke University ( email )

Box 90120
Durham, NC 27708-0120
United States
919-660-7857 (Phone)
919-660-8030 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Campbell R. Harvey (Contact Author)

Duke University - Fuqua School of Business ( email )

Box 90120
Durham, NC 27708-0120
United States
919-660-7768 (Phone)

HOME PAGE: http://www.duke.edu/~charvey

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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