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The equity premium in finance and valuation textbooks

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  • Fernandez, Pablo

    ()
    (IESE Business School)

Abstract

This 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 Info

Paper provided by IESE Business School in its series IESE Research Papers with number D/745.

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Length: 20 pages
Date of creation: 20 Apr 2008
Date of revision:
Handle: RePEc:ebg:iesewp:d-0745

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Postal: IESE Business School, Av Pearson 21, 08034 Barcelona, SPAIN
Web page: http://www.iese.edu/
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Related research

Keywords: equity premium; equity premium puzzle; required market risk premium; historical market risk premium; expected market risk premium; risk premium; market risk premium; market premium;

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  1. Brown, Stephen J & Goetzmann, William N & Ross, Stephen A, 1995. " Survival," Journal of Finance, American Finance Association, American Finance Association, vol. 50(3), pages 853-73, July.
  2. Fernandez, Pablo, 2006. "Equity premium: Historical, expected, required and implied," IESE Research Papers, IESE Business School D/661, IESE Business School.
  3. Merton H. Miller, 2000. "The History Of Finance: An Eyewitness Account," Journal of Applied Corporate Finance, Morgan Stanley, Morgan Stanley, vol. 13(2), pages 8-14.
  4. Haitao Li & Yuewu Xu, 2002. "Survival Bias and the Equity Premium Puzzle," Journal of Finance, American Finance Association, American Finance Association, vol. 57(5), pages 1981-1995, October.
  5. repec:rus:hseeco:278562 is not listed on IDEAS
  6. Philippe Jorion & William N. Goetzmann, 1999. "Global Stock Markets in the Twentieth Century," Journal of Finance, American Finance Association, American Finance Association, vol. 54(3), pages 953-980, 06.
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Cited by:
  1. Fernandez, Pablo, 2008. "160 preguntas sobre finanzas," IESE Research Papers, IESE Business School D/770, IESE Business School.

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