Equity Premium: Historical, Expected, Required and Implied

25 Pages Posted: 27 Sep 2006 Last revised: 26 May 2019

See all articles by Pablo Fernandez

Pablo Fernandez

University of Navarra - IESE Business School

Date Written: May 18, 2019

Abstract

The equity premium designates four different concepts: Historical Equity Premium (HEP); Expected Equity Premium (EEP); Required Equity Premium (REP); and Implied Equity Premium (IEP).

We highlight the confusing message of the textbooks and academic articles regarding the equity premium and its evolution. The confusion arises from not distinguishing among the four concepts and from not recognizing that although the HEP is equal for all investors, the REP, the EEP and the IEP are different for different investors.

There is a kind of schizophrenic approach to valuation: while all authors admit different expectations of equity cash flows, most authors look for a unique discount rate. It seems as if the expectations of equity cash flows are formed in a democratic regime, while the discount rate is determined in a dictatorship.

A unique IEP requires assuming homogeneous expectations for the expected growth (g), but we show that there are several pairs (IEP, g) that satisfy current prices. We claim that different investors have different REPs and that it is impossible to determine the REP for the market as a whole, because it does not exist.

We also investigate the relationship between (IEP - g) and the risk free rate.

Keywords: equity premium, equity premium puzzle, required market risk premium, historical market risk premium, expected market risk premium, risk premium, market risk premium, market premium

JEL Classification: G12, G31, M21

Suggested Citation

Fernandez, Pablo, Equity Premium: Historical, Expected, Required and Implied (May 18, 2019). Available at SSRN: https://ssrn.com/abstract=933070 or http://dx.doi.org/10.2139/ssrn.933070

Pablo Fernandez (Contact Author)

University of Navarra - IESE Business School ( email )

Camino del Cerro del Aguila 3
28023 Madrid
Spain
+34 91 357 0809 (Phone)
+34 91 357 2913 (Fax)

HOME PAGE: http://web.iese.edu/PabloFernandez/

Register to save articles to
your library

Register

Paper statistics

Downloads
10,101
Abstract Views
25,241
rank
434
PlumX Metrics