The Equity Risk Premium in 2010

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 June 2010. 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 current surveys show that the premium has returned to levels observed in late 2006 and early 2007. The survey also provides measures of cross-sectional disagreement about the risk premium, skewness, and a measure of individual uncertainty. While disagreement has decreased from peak levels, the level of disagreement is still historically high suggesting considerable uncertainty. 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.

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

JEL Classification: G11, G31, G12, G14