Unconstrained Estimates of the Equity Risk Premium
62 Pages Posted: 13 Feb 2010 Last revised: 13 Mar 2013
Date Written: January 29, 2013
Estimates of the equity risk premium implied by analyst forecasts — generally 2 to 4 percent — are often significantly below realized equity returns of 6 percent. Measurement error could result from conservative assumptions, reliance upon consensus rather than detailed forecasts, the use of market rather than target prices, and regression analysis, which can be influenced by a small number of observations. We address these potential sources of measurement error.
Our estimates are consistent with subsequently realized returns and capture systematic risk exposure. Alternative techniques could capture another form of priced risk or identify firm characteristics associated with systematic mispricing. From 1999 to 2008, we estimate an average equity risk premium in the United States of 5.3 percent. The estimate increases from 3.1 percent for 1999 to 2000 to 5.9 percent from 2001 to 2008, comparable to the historical average of realized equity returns.
Keywords: Analyst forecasts, cost of equity capital, long-term growth, equity risk premium, market risk premium
JEL Classification: G12
Suggested Citation: Suggested Citation