25 Pages Posted: 14 Sep 2009 Last revised: 20 Nov 2015
Date Written: November 18, 2015
I review 150 textbooks on corporate finance and valuation published between 1979 and 2009 by authors such as Brealey, Myers, Copeland, Damodaran, Merton, Ross, Bruner, Bodie, Penman, Arzac… and find that their recommendations regarding the equity premium range from 3% to 10%, and that 51 books use different equity premia in various pages. The 5-year moving average has declined from 8.4% in 1990 to 5.7% in 2008 and 2009.
Some confusion arises from not distinguishing among the four concepts that the phrase equity premium designates: the Historical, the Expected, the Implied and the Required equity premium (incremental return of a diversified portfolio over the risk-free rate required by an investor). 129 of the books identify Expected and Required equity premium and 82 identify Expected and Historical equity premium.
Finance textbooks should clarify the equity premium by incorporating distinguishing definitions of the four different concepts and conveying a clearer message about their sensible magnitudes.
Keywords: equity premium, equity premium puzzle, expected equity premium
JEL Classification: G12, G31, M21
Suggested Citation: Suggested Citation
By Ivo Welch