The Equity Risk Premium and the Required Share Returns in a Tobin’s q Model

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The Equity Risk Premium and the Required Share Returns in a Tobin’s q Model

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Jakob B. Madsen (Institute of Economics, University of Copenhagen)

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Jakob B. Madsen

Abstract

Based on the Tobin’s q principle this paper shows that earnings per unit of capital and the output capital ratio are excellent measures of the required share returns because they are only temporarily affected by earnings shocks but are driven permanently by changes in required share returns. Evidence for the US over the period from 1889 to 2002 suggests that real required share returns and the equity risk premium climbed to extraordinarily high levels from the late 1930, to the end of the 1940s, and have since declined. The risk premium is currently somewhere between 4 and 6%.

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Paper provided by Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics in its series EPRU Working Paper Series with number 03-10.

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Length: 20 pages
Date of creation: Sep 2003
Date of revision:
Handle: RePEc:kud:epruwp:03-10

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Find related papers by JEL classification:
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
E22 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Capital; Investment; Capacity
E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

This paper has been announced in the following NEP Reports:

NEP-ALL-2003-09-08 (All new papers)
NEP-CFN-2003-09-08 (Corporate Finance)
NEP-MAC-2003-09-08 (Macroeconomics)
NEP-RMG-2003-09-08 (Risk Management)

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Other versions:
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