This stellar stock market rally was made possible by increased capital flows into Europe, a valuation rerating and a fall in the
equity risk premium.
Because of that, Mehra and Prescott find that for reasonable values of [gamma] (10 and under), the
equity risk premium implied by the right-hand side of equation (6) is an order of magnitude smaller than the one found in the data.
Low curvature, which fits historical interest rates, implies a degree of risk aversion at least an order of magnitude too low to be compatible with the
equity risk premium observed in financial markets.
By rewarding executives only when the company's stock price increases at a rate greater than the 10-year Treasury note plus an
equity risk premium, EPOPs overcome the criticism that performance targets are too low.
Using this pricing model, the cost of
equity risk premium is valued based on the risk premium of corporate bonds, and the fluctuations of the share market and the return on government bonds.
The discount factor includes the
equity risk premium markup over risk free rates of return.
The question of
equity risk premium appropriate for Central Europe is a topic that every serious investor in the region, along with potential sellers of assets, must be pondering.
Worth: A lot of valuation professionals are dissatisfied with the
equity risk premium, the historical
equity risk premium.
It also covers the build-up and Capital Asset Pricing Models for estimating the cost of capital;
equity risk premium, beta, and the size effect; criticism of major models for developing estimates of the cost of capital and alternative models; and the Duff & Phelps Risk Premium studies, emergent tools in estimating the cost of equity capital.
One should start the process with the long-term return of the equity markets (S&P 500 or MSCI World), which is the historical
equity risk premium of about 6 percent plus the current Treasury bill return of 4 percent or so.
The discount factor, in turn, reflects expected rates of return on alternative assets, such as bonds, plus an
equity risk premium.
Finally, we measure the marginal cost of capital by the sum of the yield of the on-the-run ten-year TIPS and an (unobservable)
equity risk premium, defined as the return investors expected above and beyond the ten-year TIPS yield.
