Expectations of Equity Risk Premia, Volatility and Asymmetry from a Corporate Finance Perspective
John R. Graham
Duke University; National Bureau of Economic Research (NBER)
Campbell R. Harvey
Duke University - Fuqua School of Business; National Bureau of Economic Research (NBER); Duke Innovation & Entrepreneurship Initiative
November 30, 2001
We present new evidence on the distribution of the ex ante risk premium based on a multi-year survey of Chief Financial Officers (CFOs) of U.S. corporations. Currently, we have responses from surveys conducted from the second quarter of 2000 through the third quarter of 2001. The results in this paper will be augmented as future surveys become available.
We find direct evidence that the 10-year expected risk premium is stable and equal to about 4%. In contrast, the one-year risk premium is highly variable through time. In particular, after periods of negative returns, CFOs significantly reduce their one-year market forecasts, disagreement (volatility) increases and returns distributions are more skewed to the left.
We also examine the relation between ex ante returns and ex ante volatility. The relation between the one-year expected risk premium and expected risk is negative. However, our research points to the importance of horizon. We find a significantly positive relation between expected return and expected risk at the 10-year horizon. Finally, our last survey was delivered September 10, 2001. We are able to measure the increase in perceived risk following the September 11, 2001 crisis.
Number of Pages in PDF File: 38
Keywords: Risk premium, cost of capital, asymmetric volatility, skewness, leverage effect, expectations, risk to reward, momentum, September 11 crisis
JEL Classification: G11, G12, G31
Date posted: December 8, 2001