The 2008 Equity Risk Premium from Academia

What is the current academic estimate of the annual premium over the risk-free rate demanded by equity investors. How has that estimate changed over the past year and since 2000? In his February 2009 paper entitled “Market Risk Premium Used in 2008: A Survey of More Than a 1,000 Professors”, Pablo Fernández summarizes the results of an early 2009 email survey soliciting the risk premium “that we, professors, use to calculate the required return to equity” in 2008 and in previous years. Based on 1,161 responses to the survey from finance and economic professors around the world, he finds that:

• The average risk premium reported by U.S. professors (6.5%) is higher than those reported from Europe, Canada, the UK and Australia but lower than that reported from “Other” places.
• About 24% (15%) of respondents report raising (lowering) risk premium estimates for 2008 compared to 2007.
• About 22% (66%) of respondents report raising (lowering) risk premium estimates since 2000.

The following chart, taken from the paper, shows the distribution of the market risk premium (MRP) estimates for the 351 survey responses from finance and economics professors in the U.S. The average is 6.5%, up from the average estimate of 6.2% for the prior year. MRP is defined as the premium demanded by investors over the risk-free rate of return.

In summary, finance and economics professors on average currently estimate that investors require an annual excess return from equities in the range 5% to 7%.

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