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Determinants of the implied equity risk premium in Brazil

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  • Sanvicente, Antonio Zoratto
  • Carvalho, Mauricio Rocha de

Abstract

This paper proposes and tests market determinants of the equity risk premium (ERP) in Brazil. We use implied ERP, based on the Elton (1999) critique. The ultimate goal of this exercise is to demonstrate that the calculation of implied, as opposed to historical ERP makes sense, because it varies, in the expected direction, with changes in fundamental market indicators. The ERP for Brazil is calculated as a mean of large samples of individual stock prices in each month in the January, 1995 to September, 2015 period, using the 'implied risk premium' approach. As determinants of changes in the ERP we obtain, as significant, and in the expected direction: changes in the CDI rate, in the country debt risk spread, in the US market liquidity premium and in the level of the S&P500. The influence of the proposed determining factors is tested with the use of time series regression analysis. The possibility of a change in that relationship with the 2008 crisis was also tested, and the results indicate that the global financial crisis had no significant impact on the nature of the relationship between the ERP and its determining factors. For comparison purposes, we also consider the same variables as determinants of the ERP calculated with average historical returns, as is common in professional practice. First, the constructed series does not exhibit any relationship to known market-events. Second, the variables found to be significantly associated with historical ERP do not exhibit any intuitive relationship with compensation for market risk.

Suggested Citation

  • Sanvicente, Antonio Zoratto & Carvalho, Mauricio Rocha de, 2016. "Determinants of the implied equity risk premium in Brazil," Textos para discussão 430, FGV EESP - Escola de Economia de São Paulo, Fundação Getulio Vargas (Brazil).
    • Handle: RePEc:fgv:eesptd:430
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    References listed on IDEAS

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    1. Ľuboš Pástor & Meenakshi Sinha & Bhaskaran Swaminathan, 2008. "Estimating the Intertemporal Risk–Return Tradeoff Using the Implied Cost of Capital," Journal of Finance, American Finance Association, vol. 63(6), pages 2859-2897, December.
    2. MINARDI, Andrea Maria Accioly Fonseca & SANVICENTE, Antônio Zoratto & Montenegro, Carlos Mauro Galivi & Donatelli, Danielle Hatem & Bignotto, Fernando Graciano, 2007. "Estimando O Custo De Capital De Companhias Fechadas No Brasil Para Uma Melhor Gestão Estratégica De Projetos," Insper Working Papers wpe_81, Insper Working Paper, Insper Instituto de Ensino e Pesquisa.
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    9. Sanvicente, A. Z. & Minardi, A. M. A. F., 1999. "Problemas de Estimação de Custo de Capital no Brasil," Finance Lab Working Papers flwp_15, Finance Lab, Insper Instituto de Ensino e Pesquisa.
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    Cited by:

    1. Alexandre de Carvalho & Thiago Trafane Oliveira Santos, 2020. "Is the Equity Risk Premium Compressed in Brazil?," Working Papers Series 527, Central Bank of Brazil, Research Department.
    2. Guanais, Luiz Felipe Poli & Sanvicente, Antonio Zoratto & Sheng, Hsia Hua, 2017. "Cost of equity estimation for the Brazilian market: a test of the Goldman Sachs model," Textos para discussão 447, FGV EESP - Escola de Economia de São Paulo, Fundação Getulio Vargas (Brazil).

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