The equity premium in finance and valuation textbooks
AbstractThis paper is a review of the recommendations about the equity premium found in the main finance and valuation textbooks. We review several editions of books written by authors such as Brealey and Myers; Copeland, Koller and Murrin (McKinsey); Ross, Westerfield and Jaffe; Bodie, Kane and Marcus; Damodaran; Copeland and Weston; Van Horne; Bodie and Merton; Stowe et al.; Pratt; Penman; Bruner; Weston & Brigham; and Arzac. We highlight the confusing message of the textbooks regarding the equity premium and its evolution. The main confusion arises from not distinguishing among the four concepts that the word equity premium designates: historical equity premium (hep), expected equity premium, required equity premium (rep) and implied equity premium (IEP). Some confusion also arises from not recognizing that although the HEP is the same for all investors, the REP, the EEP and the IEP are different for different investors. A unique IEP requires assuming homogeneous expectations for expected growth (g), but 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.
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Bibliographic InfoPaper provided by IESE Business School in its series IESE Research Papers with number D/745.
Length: 20 pages
Date of creation: 20 Apr 2008
Date of revision:
equity premium; equity premium puzzle; required market risk premium; historical market risk premium; expected market risk premium; risk premium; market risk premium; market premium;
Other versions of this item:
- Fernandez, Pablo, 2006. "The equity premium in finance and valuation textbooks," IESE Research Papers D/657, IESE Business School.
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
- G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-10-21 (All new papers)
- NEP-CFN-2008-10-21 (Corporate Finance)
- NEP-UPT-2008-10-21 (Utility Models & Prospect Theory)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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- Fernandez, Pablo, 2006. "Equity premium: Historical, expected, required and implied," IESE Research Papers D/661, IESE Business School.
- repec:rus:hseeco:278562 is not listed on IDEAS
- Merton H. Miller, 2000. "The History Of Finance: An Eyewitness Account," Journal of Applied Corporate Finance, Morgan Stanley, vol. 13(2), pages 8-14.
- Fernandez, Pablo, 2008. "160 preguntas sobre finanzas," IESE Research Papers D/770, IESE Business School.
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