Unconstrained Estimates of the Equity Risk Premium

62 Pages Posted: 13 Feb 2010 Last revised: 13 Mar 2013

See all articles by Tristan Fitzgerald

Tristan Fitzgerald

University of Queensland - Business School

Stephen Gray

University of Queensland - Business School; Duke University - Fuqua School of Business; Financial Research Network (FIRN)

Jason Hall

University of Michigan, Stephen M. Ross School of Business

Ravi Jeyaraj

University of Queensland - Business School

Date Written: January 29, 2013

Abstract

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

Fitzgerald, Tristan and Gray, Stephen and Hall, Jason L. and Jeyaraj, Ravi, Unconstrained Estimates of the Equity Risk Premium (January 29, 2013). Forthcoming in Review of Accounting Studies, 2013, 18 (2), June, Accepted 26 March 2012.. Available at SSRN: https://ssrn.com/abstract=1551748 or http://dx.doi.org/10.2139/ssrn.1551748

Tristan Fitzgerald

University of Queensland - Business School ( email )

Brisbane, Queensland 4072
Australia

Stephen Gray

University of Queensland - Business School ( email )

University of Queensland
Brisbane, Queensland 4072
Australia

Duke University - Fuqua School of Business

Box 90120
Durham, NC 27708-0120
United States

Financial Research Network (FIRN) ( email )

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

Jason L. Hall (Contact Author)

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street, Ross School of Business
University of Michigan
ANN ARBOR, MI MI 48104
United States
+1 734 926 6989 (Phone)

Ravi Jeyaraj

University of Queensland - Business School ( email )

Brisbane, Queensland 4072
Australia

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