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The equity risk premium: a review of models

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  • Fernando M. Duarte
  • Carlo Rosa

Abstract

The authors estimate the equity risk premium (ERP)?the expected return on stocks in excess of the risk-free rate?by combining information from twenty models for the period 1960-2013. They begin their analysis by categorizing the models into five classes: trailing historical mean, dividend discount, cross-sectional estimation, regression analysis using valuation ratios or macroeconomic variables, and surveys. They find that an optimal weighted average of all models places the one-year-ahead ERP in June 2012 at 12.2 percent, close to levels reached in the mid- and late 1970s, when the ERP was highest in the study sample. The authors note, however, that there is considerable uncertainty in ERP point estimates. The interquartile range across models is 11.6 percent on average, although it reached 6.8 percent in 2012, the lowest level in the study sample. By employing differences across models, the authors argue that the ERP in 2012 is elevated mainly because Treasury yields are low, not because the expected future cash flows from stocks are high.

Suggested Citation

  • Fernando M. Duarte & Carlo Rosa, 2015. "The equity risk premium: a review of models," Economic Policy Review, Federal Reserve Bank of New York, issue 2, pages 39-57.
  • Handle: RePEc:fip:fednep:00027
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    References listed on IDEAS

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    More about this item

    Keywords

    stock returns; Equity premium;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • G00 - Financial Economics - - General - - - General
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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