The 2010 Equity Risk Premium from Practitioners

What is the current practitioner estimate of the annual premium over the risk-free rate demanded by equity investors. How has that estimate changed over the past year? In their May 2010 paper entitled “Market Risk Premium Used in 2010 by Analysts and Companies: A Survey with 2,400 Answers”, Pablo Fernandez and Javier del Campo summarize the results of an April-May 2010 email survey soliciting the risk premium “used to calculate the required return to equity” in 2010. Based on specific responses to the question from 601 analysts and 901 other companies around the world, they find that:

• The average risk premium reported by U.S. and Canadian analysts (5.1%) is about the same as those reported from Europe (5.0%) and UK (5.2%). The average risk premium used by other companies in the U.S. and Canada (5.3%) is smaller than those reported from Europe (5.7%) and UK (5.6%).
• Dispersion among responses within countries is fairly high (see the chart below).
• Both the average risk premium and the dispersion of risk premiums is lower among practitioners than among finance and economics professors.
• Among analysts in the U.S./Canada and worldwide, the average reported risk premium fell by 0.3% and 0.2%, respectively, from 2009 to 2010. Among other companies, the decrease is somewhat smaller. About 11% (32%) of analysts report raising (lowering) risk premium estimates for 2010 compared to 2009.
• The top four cited benchmarks for the equity risk premium from analysts and other companies are, in descending order: internal estimates, Damodaran, Morningstar/Ibbotson and historical data.

The following chart, taken from the paper, shows the distribution of required equity risk premiums for 104 survey responses from analysts in the U.S. and Canada. The average is 5.1%, down from the average estimate of 5.4% in 2009.

In summary, U.S. and Canadian financial analysts on average currently estimate that investors require an annual excess return from equities of 5.1%.

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