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Measuring the equity risk premium

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Abstract:

We use surveys of economic forecasts to derive a forward-looking estimate of the US equity risk premium (ERP) relative to government bonds. Our ERP measure helps predict short-term relative returns between stocks and bonds. Over the period we studied, low readings of the ERP tended to adjust back to the mean via a rally in the bond market rather than a fall in stock prices. We do not generalise from this result, however, as our sample period is characterised by strong trends of falling inflation and rising stock prices. Our estimate of the expected ERP — averaging just over 2 per cent — is markedly lower than the premium that historical studies show has been realised. Data from the UK paint a similar picture to the US experience.Journal of Asset Management (2001) 1, 245–256; doi:10.1057/palgrave.jam.2240019

Document Type: Research Article

DOI: http://dx.doi.org/10.1057/palgrave.jam.2240019

Affiliations: 1: 1Old Mutual Asset Managers Limited, 80 Cheapside, London, EC2V 6EE, UK., Tel: +44 20 7332 7558, Email: peter.best@omam.co.uk 2: 2Head of Investment Strategy at AEGON Asset Management in Edinburgh

Publication date: January 1, 2001

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