equity risk premium

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Equity Risk Premium

The return that an investor expects over and above the risk-free rate of return in exchange for investing in common stock instead of U.S. Treasury bonds. The equity risk premium may be calculated as the return such a stock actually earns over a given period. For example, if the interest rate on a Treasury bond is 4% and the stock returns 9%, the equity risk premium is 5%. Whether or not this is worth the investment depends on the cost of the stock, the risk relative to other stocks with similar returns, and the investor's own risk aversion. The equity risk premium is also called simply the equity premium.

equity risk premium

The extra return expected from investments in common stocks compared to the return from U.S. Treasury securities.
References in periodicals archive ?
Deliberations on the stock market participation puzzle may provide with the necessary inputs for solving the equity premium puzzle given by Mehra and Prescott (1985).
Recursive preferences allow one to account for the equity premium puzzle in two ways.
Coverage includes an introduction to modern asset pricing, the authors' new structural theory and its application to the equity premium puzzle, use of the structural theory to deal with an enlarged portfolio space that includes non-tradable assets, discussion of asset pricing problems including both bottom-up and the top-down investment methodologies, and the relationship of the portfolio insurance with option and consumption-based asset pricing models.
Bansal also surveys a large literature that has adopted this long-run risk model to study a variety of puzzles in the asset pricing literature, including the equity premium puzzle, the excessive volatility puzzles, and the predictability of returns across assets sorted by size, momentum, and book-to-market values.
In discussing risk aversion, the authors hint at the equity premium puzzle.
Since Shiller (1982) and Mehra and Prescott (1985) questioned why the gap between the rates of returns from stocks and bonds is so large, the equity premium puzzle has attracted the attention of many economists.
These results help explain why consumption covariance with equity returns is so low, giving rise to the equity premium puzzle.
The first was christened the equity premium puzzle by Mehra and Prescott (1985): Why is the average real stock return so high (in relation to the average short-term real interest rate)?
One common informal interpretation of this equity premium puzzle is that stocks are a good deal.
Because standard economic theory cannot satisfactorily explain why stock returns have been so high relative to other instruments, this fact has become known as the equity premium puzzle.
The potential for this research was illustrated recently by George Constantinides's [1990] resolution of the equity premium puzzle in a model that included habit formation in consumption.
Solves the equity premium puzzle by showing that it is consistent with findings on loss aversion