Rethinking the Equity Risk Premium - Chicago Global


In 2001, a small group of academics and practitioners met to discuss the equity risk premium (ERP). Ten years later, in 2011, a similar discussion took place, with participants writing up their thoughts for this volume. The result is a rich set of papers that practitioners may find useful in developing their own approach to the subject.

The past 10 years have shown that the ERP, far from being a settled matter, continues to challenge analysts. The research and observations in this volume have a number of implications for investment practice and theory. First, investors and analysts should take care to be explicit about their estimates of the ERP. We still too often use different definitions of, assumptions about, and approaches to the ERP, or leave it altogether implicit in our analyses of asset markets and valuations. Further clarity may help reduce the number of occasions when we are talking past each other. Second, we should be clear about what model we are using when we offer a forecast or explanation of the ERP.

We have seen that variations in our estimates can be the result of different approaches to objective, circumstantial, and behavioral factors. Third, differing circumstances among investors lead to true, irreducible differences in the ERP that each investor may face at any given time. This final consideration underscores how the interplay of these multiple circumstantial forces can lead to a risk premium that is far more multifaceted and complex than typically envisioned in the standard discount models, even when we take into account structural and cyclical changes in the more objective factors. The papers contained in this volume richly illustrate this interplay.

p. Brett Hammond, Jr., martin L. Leibowitz, and Laurence B. Siegel