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The Prospective “Academic” Equity Risk Premium

| | Posted in: Equity Premium

What is the latest reading on the future equity risk premium from the academic community? In his January 2008 paper entitled “The Consensus Estimate For The Equity Premium by Academic Financial Economists in December 2007”, Ivo Welch answers this question. Based on 369 “core” responses to a survey of finance professors conducted during late December 2007, he finds that:

  • As of the end of 2007, survey respondents estimate the one-year equity risk premium and the 30-year geometric mean equity premium to be about 5%, translating to a 9% expected rate of return for stocks.
  • They estimate the 30-year arithmetic mean equity premium to be about 0.7% higher than the geometric mean, implying 12-13% annual volatility.
  • The geometric mean equity premium forecast for 2007 is about 0.7% more bearish than the similarly estimated 2001 forecast.
  • Respondents estimate the average annual probability of a decline in the stock market at one third. They estimate the probability of a 20% one-year decline at a fat-tailed 10%.

The following chart summarizes key findings of the December 2007 survey of 369 U.S. finance professors.

In summary, U.S. finance professors on average, as of the end of 2007, expect stocks to offer a 5% annual (geometric) risk premium over the next 30 years, a little below their expectation in 2001.

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