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 ?
In the last part of the paper we present estimations concerning the Polish financial market and we try to combine the results with the proposed solutions to the equity premium puzzle.
Using the insight that search and matching frictions affect asset pricing through a liquidity premium, Lagos (2010) used a third-generation model to address the equity premium puzzle and the risk-free rate puzzle.
Recursive preferences allow one to account for the equity premium puzzle in two ways.
Com efeito, Mehra e Prescott (1985) pioneiramente se deram conta de que os premios de mercado ex post medios, estimados entre 1889 e 1978 nao poderiam ser explicados senao por uma aversao relativa ao risco dos agentes incompreensivelmente alta (cerca de 40, segundo os autores, quando o esperado pelos modelos teoricos seria entre 1 e 2), resultados estes ratificados por Kocherlakota (1996) ao empregar uma base de dados ampliada em 10 anos -- foi o surgimento do denominado Equity Premium Puzzle, um paradoxo entre a relativa aversao ao risco esperada para os agentes ditos racionais segundo os modelos economicos intertemporais e os premios de mercado obtidos a partir de series historicas.
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.
The fact that the model in this paper produced an equity premium higher than the actual one is evidence that the equity premium puzzle (Mehra and Prescott 1985) does not show up in this paper's model.
Habit forming preferences have been notably successful in solving the equity premium puzzle.
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.
Liquidity can thus play a role in resolving a number of asset pricing puzzles such as the small-firm effect, the equity premium puzzle, and the risk-free rate puzzle.
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)?