Blog - Investing Notes
November 22, 2006 - Honing in on the
Prospective U.S. Equity Risk Premium
What is the latest from academia regarding the prospective equity risk premium? In their November 2006 paper
entitled "Estimating the Ex Ante Equity Premium", Glen Donaldson,
Mark Kamstra and Lisa Kramer apply new simulation techniques across
ten distinct models to calculate what they claim "is by far the
most precise equity premium estimate that has been reported in the literature
to date." Using U.S. dividend growth rates, interest rates, Sharpe
ratios, price-dividend ratios, return volatilities and the historical
equity premium for 1952-2004 to calibrate their simulations, they
conclude that:
- A low dividend yield, high historical equity risk premium, high
return volatility and high Sharpe ratio over the last five decades
are jointly informative regarding the prospective equity risk premium.
- The prospective U.S. equity risk premium is 3.5% +/- 0.5%.
In summary, investors expect annual equity returns of 3-4% over
the risk-free rate in coming years.
For other research on the equity risk premium, see Blog
Synthesis: The Equity Risk Premium.
