The Equity Risk Premium: A Contextual Literature Review

39 Pages Posted: 18 Dec 2017

Date Written: November 1, 2017

Abstract

Research into the equity risk premium, often considered the most important number in finance, falls into three broad groupings. First, researchers have measured the margin by which equity total returns have exceeded fixed-income or cash returns over long historical periods and have projected this measure of the equity risk premium into the future. Second, the dividend discount model - or a variant of it, such as an earnings discount model - is used to estimate the future return on an equity index, and the fixed-income or cash yield is then subtracted to arrive at an equity risk premium expectation or forecast. Third, academics have used macroeconomic techniques to estimate what premium investors might rationally require for taking the risk of equities. Current thinking emphasizes the second, or dividend discount, approach and projects an equity risk premium centered on 3½% to 4%.

Suggested Citation

Siegel, Laurence B., The Equity Risk Premium: A Contextual Literature Review (November 1, 2017). CFA Institute Research Foundation Volume 12, Issue 1, pp. 1-30, November 2017, ISBN: 978-1-944960-31-5, Available at SSRN: https://ssrn.com/abstract=3088820 or http://dx.doi.org/10.2139/ssrn.3088820

Laurence B. Siegel (Contact Author)

CFA Institute Research Foundation ( email )

United States

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