Expected and Required Returns: Very Different Concepts

Abstract

The expected return is different than the required return. We explain it for an investment project, for the valuation of a share of Coca-Cola and for the market risk premium.

However, there are many valuations that assume that the expected return is equal to the required return. Similarly, Expected Equity Premium (EEP) and Required Equity Premium (REP) are two very different concepts, although many books and financial literature do not distinguishing them. Both, the REP and the EEP differ for different investors.

The topic of this short paper (4 pages) is “thinking about valuation”: it is important to understand what we are doing.

Keywords: expected return, required return, required equity premium, expected equity premium, market risk premium

JEL Classification: G12, G31, M21