The Equity Risk Premium: A Consensus of Models

Abstract

We estimate the equity risk premium by combining information from twenty models. Our main finding is that there is broad agreement across models that the equity premium reached historical heights in July 2013 even when the models are substantially different from each other and use more than one hundred different economic variables. Our preferred estimator places the one-year-ahead equity premium in July 2013 at 14.5 percent, the highest level in fifty years and well above the 10.5 percent that was reached during the financial crisis in 2009. The models also show broad agreement that the term structure of equity risk premia is high and flat: expected excess returns at all foreseeable horizons are just as high as at the one-year horizon. A high equity premium that is not expected to mean-revert in the near future is an unprecedented phenomenon. Because expected dividend growth has not been above average in 2013, we conclude the high equity premium is mostly due to unusually low discount rates at all horizons.

Keywords: Equity risk premium, ERP, bond yields, stocks, term structure, stock prices

JEL Classification: G10, G11, G12, C52, C53