Sunday, May 19, 2013

Equity Risk Premiums (ERP) and Stocks: Bullish or Bearish Indicator

If you have been following my blog postings, you are probably aware that I have an obsession with equity risk premiums (ERP), and have done an annual survey paper on the topic  every year since 2008 (with the 2013 update here). I also post a monthly update for the ERP for the S&P 500 at the start of the month on my website. As a consequence, my attention was drawn to a post by Fernando Duarte and Carlo Rosa, economists at the Fed in New York, on the topic. They argue that equity risk premiums are at historic highs, primarily because the US treasury rates are low, and note that these high equity risk premiums are a precursor to good stock returns in the future. I don’t disagree with their authors that equity risk premiums are high, relative to history and that the low risk free rate is in large part responsible these large premiums, but I am less sanguine about using the ERP as a market timing device, especially at this time in history.

Measurement approaches
There are three ways of estimating an equity risk premium. One is to look at the difference between the average historical return you would have earned investing in stocks and the return on a risk free investment. This historical premium for the 1928-2013 time period would have stood at about 4.20%, if computed as the difference in compounded returns on US stocks and on the 10-year US treasury bond. (I know. I know. We can have a debate about whether the US treasury is truly risk free, but that is a discussion for a different forum.) The second is to survey portfolio managers, CFOs or investors about what they think stocks will generate as returns in future periods and back out the equity risk premium from these survey numbers. In early 2013, that survey premium would have yielded between 3.8% (from the CFO survey) to 4.8% (portfolio managers) to 5% (analysts). Finally, you can back out a forward looking premium, based upon current stock prices and expected cash flows, akin to estimating the yield to maturity on a bond. That is the process that I use at the start of every month to compute the ERP for US stocks, and that number stood at 5.45% On May 18, 2013

What is the ERP? 
The equity risk premium is the extra return that investors demand over and above a risk free rate to invest in equities as a class. Thus, it is a receptacle for investor hopes and fears, with the number rising when the fear quotient dominates the hope quotient. In buoyant times, when investors are not fazed by risk and hope is the dominant force, equity risk premiums can fall. In the graph below, you can see my estimates of the implied equity risk premium for US stocks from 1961 to 2012 (year ends) with annotations providing my rationale for the shifts over time periods. 
The average implied equity risk premium over the entire period is 4.02% and that number is the basis for the bullishness that some investors/analysts bring to the market. If the equity risk premium, currently at 5.45%, does drop to 4.02% , the S&P 500 would trade at 2270, an increase of 26.5% on current levels. And history, as Duarte and Rosa note, is on your side, albeit with significant noise, in making this assumption that equity risk premiums revert back to norms over time. As I will argue in the next section, the high ERP in 2013 is very different from high ERPs in previous time periods and extrapolating from past history can be dangerous. 

A Fed-engineered ERP?
This equity risk premium, though, is over and above the risk free rate. To provide a sense of the interplay between the risk free rate and the equity risk premium, I plot the expected return on stocks (based upon future cash flows and current stock prices), decomposed into the equity risk premium and  the and the risk free rate each year from 1962 to 2012. 


Over the last decade, the expected return on stocks has stayed surprisingly stable at between 8-9% and almost all of the variation in the ERP over the decade has come from the risk free rate. In particular, the higher ERP over the last five years can be entirely attributed to the risk free rates dropping to historic lows. In fact, the expected return on stocks on May 18, 2013 of 7.40% is close to the historic low for this number of 6.91% at the end of 1998. 

So what? While the relationship between the level of the ERP and the risk free rate has weakened over the last decade, the two numbers have historically moved in the same direction: as risk free rates go up (down), equity risk premiums have risen (fallen). In fact, a regression of the ERP on the ten-year US treasury bond rate from 1960-2012 is presented below: 
ERP = .0348                            + .0842 (US T. Bond Rate) R squared = 4.68% 
(1.57) 
Thus, an increase of 1% in the ten-year bond rate (from 2% to 3%, for instance) increases the ERP by 0.0842%. In fact, running the regression through from 1960-2003 (excluding the last decade) yields an ever stronger result: 
ERP = .0202                           + .2592 (US T. Bond Rate) R squared = 43.52% 
(5.62) 
During this period, a 1% increase in interest rates would have led to an increase of 0.26% in the ERP. The last decade has weakened the relationship between the ERP and the T.Bond rate dramatically.

In light of this evidence, consider again two periods with high ERPs. In 1981, the ERP was 5.73%, but it was on top of a ten-year US treasury bond rate of 13.98%, yielding an expected return for stocks of 19.71%. On May 1, 2013, the ERP is at 5.70% but it rests on a US treasury bond rate of 1.65%, resulting in an expected return on 7.35%. An investor betting on ERP declining in 1979 had two forces working in his favor: that the ERP would revert back to historic averages and that the US treasury bond rate would also decline towards past norms An investor in 2013 is faced with the reality that the US treasury bond rate does not have much room to get lower and, if mean reversion holds, has plenty of room to move up, and if history holds, it will take the ERP up with it.

In the table below, I list potential consequences for the S&P 500, in terms of percentage changes in the level of the index, of different combinations of the risk free rate and the ERP: 


Thus, if risk free rates move to 3% and the equity risk premium drops to 5%, the index is undervalued by about 5%, but if rates rise to 4% and the equity risk premium stays at 5.5%, the index is overvalued by 8.28%. There is another interesting aspect to the table that bears emphasizing. While the sum of the risk free rate and equity risk premium is the expected return on stocks, stocks are worth much more for any given expected return, if more of that expected return comes from the risk free rate. In the figure below, note the S&P index levels for an expected return of 9%, using different combinations of the risk free rate and ERP: 


Thus, the same mean reversion that market bulls point to with the ERP can be used to make a bearish case for stocks. The historical average expected return for stocks between 1960 and 2012 of 10.43%, this would translate into the S&P 500 being over valued between 12-40%, depending upon the composition of the expected return. In fact, that is the reason that you have the large divergence in the market between those who use normalized PE ratios and argue that stocks are massively overpriced and those who use the equity risk premium or the Fed model today to make the opposite case.  I am sure that you have your own views on both where the risk free rate and the equity risk premium are headed. If you want to explore the effect on stock prices of changing the variables, please use the linked spreadsheet

Bottom line
In a previous post, I noted that stocks do not look over priced. While you may feel that this post is in direct contradiction, let me hasten to provide the bridge between the two.  In the prior post, I noted that stock prices are being sustained by four legs: (1) robust cash flows, taking the form of dividends and buybacks at historic highs for US companies, (2) a recovering economy (and earnings growth that comes with it), (3) ERP at above-normal levels and (4) low risk free rates. Thus, my argument is a relative one: given how other financial assets are being priced and the level of interest rates right now, stocks look reasonably priced. 

The danger, though, is that the US T.Bond rate is not only at a historic low but that it may be too low, relative to its intrinsic level, based upon expected inflation and expected real growth (a topic for another blog post coming soon). If you believe that the T.Bond rate is too low, then you have the possibility that you are in the midst of a Fed-induced market bubble(s) and that script never has a good ending. The scary part is that there are no obvious safe havens: gold and silver have had a good run but don’t seem like a bargain and central banks around the world seem to be following the Fed’s script of low interest rates. You could use derivatives to buy short term insurance against a market collapse but, given that you are not alone in your fears about the market, you will pay a hefty price. 

There is a middle ground. In my last ERP update, I argued that stock market investors were dancing to the Fed’s tune and wondering whether the music would stop. Let me rephrase that. If the market is dancing to the Fed’s tune, it is not a question of whether the music will stop, but when. When long term interest rates move back up, as they inevitably will, the question of how much the equity markets will be affected will depend in large part on whether the ERP declines enough to offset the interest rate effect. Thus, while I would not be arguing that stocks are cheap, simply because the ERP today is higher than historic norms, I am not ready to scale down the equity portion of my portfolio (especially since I have no place to put that money). Looking at the table of market sensitivity to risk free rate/ERP combinations, there are enough soft landing scenarios for the market that I will continue to buy individual stocks, while keeping an eye on the ERP & T.Bond rate.

139 comments:

Andy Harless said...

3 comments

1. I'm not sure what valuation model you're using to get "Value of S&P 500" in your chart. Normally if no explanation is given I would assume that you are just discounting expected cash flows at the expected rate of return, but that would imply (unless the expected cash flows are different for different ERP/RFR combinations) that the value is independent of the composition of that expected rate of return, so apparently that is not what you're doing here. But what are you doing?

2. The crux of your argument here seems to be the positive historical correlation between movements in the risk free rate and movements in the equity risk premium, which -- if it continues to be true in the future -- would mean that expected mean reversion in today's risk free rate would be associated with a rise in the equity risk premium (and hence falling stock prices -- or at least more-slowly-rising-than-usual stock prices). However, given that the equity risk premium is near a historic high, that scenario is kind of implausible. You have to imagine that, when we get back to normal business cycle conditions (which will be associated with a rising risk free rate), the equity risk premium will move to new historic highs. But why would that be? I think rather that the historical correlation is due to factors that don't apply today.

3. It doesn't make sense to me to consider expected stock returns in isolation. Based on valuation measures like dividend yields and P/E ratios, we might expect that stock returns going forward will be a little less than normal. However, the choice is not between owning stocks and owning nothing; it's between owning stocks and owning something else. The relevant "something else" today has a much lower expected return than usual. So a rational investor, even if he expects stocks to have a slightly lower return than usual, will choose to buy stocks at these prices. Now, if we assume that investors tend over time to move toward rational behavior, this implies that stock prices will rise until stocks are not obviously a better buy than bonds -- even if this means the expected return on stocks at the point will be quite low.

Andy Harless said...

And a fourth comment:

You seem to be using nominal interest rates, rather than real rates, to measure the risk free rate. So what you're really getting is mostly a measure of expected inflation. The correlation between movements in risk free rates and movements in the ERP is really mostly (or maybe entirely or even more than entirely) a correlation between movements in the expected inflation rate and movements in the ERP. This does not surprise me, in that times of high expected inflation are typically times of high expected risk. However, today, I believe the Fed has developed quite a lot of credibility, and any increases in expected inflation associated with recovery are likely to be temporary and likely, if anything, to be associated with reductions, rather than increases, in expected risk.

Anonymous said...

In the table of market sensitivity to risk free rate/ERP combinations, we can get to the "market index overvalued by 8.28%" when risk free rate=4% and ERP=5.5%, not 5%.

Shiv said...

I suppose it comes down to trying to figure why interest rates are so low.

Suppose interest rates were 3.5%, what would happen. Most likely a deeply inverted yield curve - i.e. long yields would stay low.

The long end of the yield curve yields low, because there is no private demand for leveraged productive capital. QE has lowered long yields a little bit further, but I suspect most of its being low is because of no competing higher yield demand from private parties requiring productive leveraged capital (& in the case of US T's the safe haven factor pushes yields even lower).

When will interest rates rise? I think once corporates have returned sufficient cash from their hugely cash overweighted balance sheets. And this would need to be combined with rising demand for productive leveraged capital, which will only come when there is growth. And even when there is growth, the initial capital will likely be raised through equity issuance if the markets are substanitally over-valued.

I suspect once interest rates rise, there will be a decline in stock markets. But assuming that the treasury bubble deflates slowly rather than pops which is what I believe most likely to occur, the slow rise in interest rates will be offset by rising growth expectations. The reversion of ERP to 4-4.2% may occur through rising interest rates, offset by rising growth expectations at a slightly lower rate. Put differently, multiple contraction combined with decent growth may lead to no dramatic falls in markets even while ERP & valuation revert.

In some ways low interest rates at the short end of the yield curve are not an option. They are low because if they were high, the credit markets would totally dysfunctional, because at the longer end there would be no demand for debt. QE on the other hand is another story. Its pushing down the long end of the yield curve because of buying from Central Banks. Its flattening the yield curve & adding liquidity which is leading to some overvaluation in all asset classes (but none more than long duration US T's).

The benefit is creation of public demand for leveraged capital to replace absent private demand for leveraged capital. And that could help growth. To some extent, the lowering of public demand for leveraged capital which is now occuring is not a bad idea. But if the growth now being seen in US is not self sustaining, it would be a drag. I'd be much happier in seeing public demand for leveraged capital drop away after growth remains over 2.5% for 1 to 1.5 years while unemployment falls to 6.5% or even a bit lower.

In the period when US public demand for leveraged capital is absent, the Fed's QE is adding risk to other markets where there is stronger private demand for leveraged capital.

I'd do believe that SP500 is somewhat over valued at present. But 14% to 15% over valued. That kind of over valuation can sustain for long periods as long as growth expectations provide support.

Shiv said...

In light of this evidence, consider again two periods with high ERPs. In 1981, the ERP was 5.73%, but it was on top of a ten-year US treasury bond rate of 13.98%, yielding an expected return for stocks of 19.71%. On May 1, 2013, the ERP is at 5.70% but it rests on a US treasury bond rate of 1.65%, resulting in an expected return on 7.35%.

In 1981 real interest rates were at 3%. But what were real interest rate expectations? In the absence of hard data I assume expectations of a reversion to a very long term rate of 1% real interest rates would not have been unreasonable. That would take the market real return expectation to 6.73%. Today real interest rates are negative 0.3%. I suspect a reversion of long term real interest rates to 1% is likely over time (as it happens a 10 year median inflation is 2.2% while 10 year nominal rates are 3.34% giving a median 10 year real rate of 1.1%). SO really a real return expectation of 6.7% is not unreasonable.

The big difference between now and 1981 is that in 1981 bonds were priced to win (with falling rates), while now bonds are priced to lose (with rising rates).

Shiv said...

Last note, ERP now 5.7%; 1981 5.73%. Median 10 Y Real Interest Rates now 1.1%; Median 10 Y Real Interest Rates in 1981 0.08%. Assuming reversion of real interest rates to 10Y median is an expectation, return expectation now is 6.7% while in 1981 it would've been 5.65%. Now that is consistent with a market where debt is over valued now compared to a market where debt was under valued in 1981. Expectation that money would flow from equity to debt then & from debt to equity now.

Aswath Damodaran said...

Andy,
On (1), I do use a discounted cash flow model and the model is in the spreadsheet linked to in the model. The perpetual growth rate is tied to the risk free rate (as it should be in any internally consistent DCF model). Hence, the link between the composition of the expected returns and stock levels.
On (2), you may be right about historical correlations not applying but you cannot be selective about the mean reversions that you think will apply. The same argument can be made about ERP reverting back to the mean.
On (3), you have a good point about real interest rates, but I don't think that that nominal interest rates can be waved away. There is a big difference between a negative real interest rate at a 10% nominal rate and one at at a 2% nominal rate.
On (4), see (1).

Andy Harless said...

Aswath:
"The perpetual growth rate is tied to the risk free rate (as it should be in any internally consistent DCF model)"

I think this would be true in a long-run equilibrium, but we are clearly far from that equilibrium now. 10-year TIPS yields are negative. Surely one shouldn't expect real cash flow growth to be negative. The market is clearly in disequilibrium, and besides, the equilibrium conditions don't apply when the Fed is deliberately bidding down the term premium.

Regarding (2), I do think that both ERP and the risk-free rate will revert to the mean. However, the former should happen because of the behavior of rational investors, behavior that will, if anything, be encouraged by policymakers, and therefore should happen relatively quickly. The latter is a business cycle phenomenon that is being deliberately manipulated (with good reason, in my opinion) by policymakers. It will happen at the rate that policymakers allow it to happen, so we're talking about business cycle frequencies. It's difficult for me to imagine a scenario where both reversions happen at the same rate, unless we get a whole lot of strong economic news in a short time (but if that happens, the expected cash flows from stocks will also likely rise, so you could get rising prices despite mean-reverting interest rates).

Max said...

Even though interest rates are unusually low, it's possible that they are at the same time artificially high. By that I mean, the rates are being determined by the central bank rate floor rather than by fundamentals. If that is correct, then an improvement in conditions will not translate into higher rates.

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pflood77 said...

had a quick look at the spreadsheet- please check cell references. the Goal Seek refers to blank cells. - not 100% sure what the spreadsheet is supposed to calculate.

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Why not putting a post for the Empire State Building IPO and the valuation .....

Aswath Damodaran said...

pflood,
Sorry about the goal seek suggestion. That was a carry over from a different version of the spreadsheet, where I compute an implied ERP. The purpose of this spreadsheet is simpler. It is to pick a combination of the risk free rate and ERP and see the consequences for stock prices.

Anonymous said...

Perhaps the viability of any of the approaches mentioned can be somewhat enhanced by a combination of them? By this I mean. What is the correlation between your estimated returns and actual subsequent returns? Or in the case of expected erp, now about realised erp 10 years post?

Should the correlations not be reasonably strong then perhaps we can spend less time debating it? Culd you throw those results up on your charts professor?

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Anonymous said...

Hi prof

Thanks for this post - particularly relevant in view of whatever's happening in the bond markets. Getting a bit confused, with bond yields now edging higher on the back of improved growth, would u expect equity risk premium to increase (alongside risk-free), or would you hold market return steady and reduce ERP?

If the latter applies, is it a right inference that high-beta stocks would benefit in such an environment. Appreciate your insights

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Hi, professor. I'm a fan of your blog and online classes.

May I suggest you do an article on the japanese stock market. I thought the cash flows were there for quite some time, and nothing would happen. Now there's this huge volatility since november and I think the reason may be that most stockholders are now short term speculators.

It would be great to read your opinions on valuation and other thoughts on the Nikkei.

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Hi Professor ! Can you please please please do a blog on Aggregate ROE and Marginal ROE, so that Return on Equity for existing investments and Return on Equity for new investments can be separated, sliced and diced. Please professor. Thanks :)

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Sumit A. said...
This comment has been removed by the author.
Sumit A. said...

Dear Mr. Damodaran, Thanks for this. I wish to clarify if the DV01 for Rf is so much lesser than DV01 for ERP (assuming the Rf on shorter end of the curve will remain low). Essentially assuming different delta Rf across the curve.
If not, then why is effect of ERP so much more pronounced than Rf. Thanks

C MacDonald said...

Professor, are you able to provide a link to the source of the top down earnings estimates in your ERP estimate of 5.45% on May 18, 2013? Thanks for a very interesting post.

Sumit A. said...

Oh ! what a blunder I made when i raised the doubt.

Of course a change of 1% in Rf, has to be distributed over all the equity and its impact will be roughly half of 1% change in ERP, given a leverage of 1/3 rd on balance sheet.

Sumit A. said...

Actually even lesser, maybe 1/3rd if we include taxation.

Sumit A. said...
This comment has been removed by the author.
Sumit A. said...

i guess 1% reduction in riskless rate, can reduce liability by 7% (depending on duration of liabilities); and considering a D/E of 1/2 , give return on equity of around 3.5% pretax or 2.3% post.So that's the number i would expect it to add to stock price. thanks

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Anonymous said...

If risk free rate goes up because FED will tighten but with not companion of stronger growth (FED will tighten because there is an incriesing fear of bubbles), ERP could stay high or can go even higher, thus we could have an overpriced market. Add this to all unintended consequences by FED policies to EM markets/economies, tighten will hit hard to them. Do we have a prolem?

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Jim said...

One issue I have about the notion of equity risk premium is the idea that there is a single premium which applies to all forward time periods. I think it would be reasonable to have a term structure similar to risk free rate - though admittedly it would be harder to compute it as you would have to have some kind of assumption about what the shape of the yield curve actually looks like.

In my experience, cash flows far into the future are more risky than near term rates (part of which is captured in your long term growth rate assumption for a DCF) - but really, there should be a growing "time premium" involved in the calculation of the ERP as well as well. Not sure how one would be able to prise this apart.

so: equity risk(time=t) = risk-free-rate(t) + equity_risk_premium(t) + liquidity_premium(t).

RFR and ERP would both be constants for all future t, but the liquidity premium would be an increasing function of t. I'd also argue that one should look at the yield curve for the 10-yr treasuries and modify the RFR in the same way.

I'd be curious the impact on the ERP as a result - does this assumption really make a big difference (i.e more than the margin of error)?

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Eric said...

Hi Aswath,

Let say I want to valuate a company in Euro in a mature market (Germany). What would be the Equity Risk Premium in Germany?
Can we use the implied ERP for the S&P 500 since EUR and USD have pretty much the same inflation rate?
Is there any other adjustment to convert a USD ERP to another currency's ERP?

Thank you for all your insightful posts!!
Eric

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http://www.economist.com/blogs/buttonwood/2013/07/investing?fsrc=nlw|newe|7-8-2013|6081501|36695969|

Another take on long term returns.

Anonymous said...

thanks for the great posting...I look forward to the rest of the series.

regarding the cost of equity:
"While the sum of the risk free rate and equity risk premium is the expected return on stocks, stocks are worth much more for any given expected return, if more of that expected return comes from the risk free rate."

I do not believe this is true...all one has to get right is the cost of equity...it does not matter if you get the breakdown of the ERP and RF correct - so long as the combined cost of equity is correct.

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Christopher T. Mahoney said...

Given that inflation and nominal growth are both "subdued", I see no reason why bond yields should rise.
Hence, I see stock prices today as both safe and cheap.

Alex George said...

Aswath,

Looking at historical expected returns can be dangerous. It would be better to look at historical realised returns when breaking down the components of a return into the ERP and risk free rate.

Specifically, what benefit are your historical expected returns if they do not predict historical realised returns well.

Alex

neroden@gmail said...

" historical premium for the 1928-2013 time period "

Bad comparison point. Most of the 1935-2008 period was anamolous historically. Have you got the historical premium for the 19th century? Our institutions right now are much more like the 19th century ones (in terms of unreliability, corruption, economic management, etc.) than like the 20th century ones.

neroden@gmail said...

"
On (2), you may be right about historical correlations not applying but you cannot be selective about the mean reversions that you think will apply. The same argument can be made about ERP reverting back to the mean."

For a reversion to the mean, you need a proper historical mean. You don't have one if your data only starts in 1928. A good mean would use data going back to at least 1800, perhaps even as far back as 1650.

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Anonymous said...

Can you please explain the following non-sequitur from Prof. Damodaran ERP blog.

STATEMENT 1: “Over the last decade, the expected return on stocks has stayed surprisingly stable at between 8-9% and almost all of the variation in the ERP over the decade has come from the risk free rate. In particular, the higher ERP over the last five years can be entirely attributed to the risk free rates dropping to historic lows.”

STATEMENT 2: “While the relationship between the level of the ERP and the risk free rate has weakened over the last decade, the two numbers have historically moved in the same direction: as risk free rates go up (down), equity risk premiums have risen (fallen).”

Statement 1 and Statement 2 directly conflict with each other. Statement 1 does not demonstrate the historical correlation has “weakened”, but it rather entirely dismisses the notion of any positive correlation at all.

Further:

“An investor betting on ERP declining in 1979 had two forces working in his favor: that the ERP would revert back to historic averages and that the US treasury bond rate would also decline towards past norms” THIS STATEMENT CONFLICTS WITH RELATIONSHIP IN 1 ABOVE

“An investor in 2013 is faced with the reality that the US treasury bond rate does not have much room to get lower and, if mean reversion holds, has plenty of room to move up, and if history holds, it will take the ERP up with it.” WHY WOULD A RISING T RATE MYSTERIOULSY TAKE THE ERP UP WITH IT WHEN IN FACT, AS STATEMENT 1 SAYS, THE EXPECTED RETURN OF THE MARKET HAS BEEN STABLE, ERGO, THE DROPPING T RATE ACCOUNTS FOR THE ENTIRE RISE IN ERP OVER THE LAST 5 YEARS???

“Thus, if risk free rates move to 3% and the equity risk premium drops to 5%...” THE ASSUMED SCENARIO DESCRIBED HERE IS IMPLAUSIBLE BASED ON STATEMENT 2. IS THE RELATIONSHIP BETWEEN ERP AND RISK-FREE MORE AKIN TO STATEMENT 1 OR STATEMENT 2?? IT CANT BE BOTH OTHERWISE EVERY FORECAST MODEL THAT IS PREDICATED ON A RELATIONSHIP BETWEEN RISK-FREE AND ERP WOULD BE INVALID AS ONE RELATIONSHIP IS POSITVELY CORRELATED AND ONE IS NEGATIVELY CORRELATED.

Thanks

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The process of calculating the equity risk premium, and selection of the data used, is highly subjective to the study in question, but is generally accepted to be in the range of 3-7% in the long-run.

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The annual headline inflation is expected to moderate to near 5 percent as there was reasonable price stability in some major commodities, the finance minister said on Thursday.
P. Chidambaram made the comment in a lecture at the National University of Singapore.
India's wholesale price index based headline inflation rose to an eight-month high in October at 7 percent, driven by costlier fuel and manufactured goods, raising the prospect of a fresh interest rate hike.

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The crux of your argument here seems to be the positive historical correlation between movements in the risk free rate and movements in the equity risk premium, which -- if it continues to be true in the future -- would mean that expected mean reversion in today's risk free rate would be associated with a rise in the equity risk premium (and hence falling stock prices -- or at least more-slowly-rising-than-usual stock prices). However, given that the equity risk premium is near a historic high, that scenario is kind .
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The Sensex, which spurted to 21,017.45, is now down 56.65 points or 0.27% at 20,803.21. The Nifty is down 23.10 points or 0.37% at 6194.05, after rising to 6263.75 at the start.

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iwin said...

I think this would be true in a long-run equilibrium, but we are clearly far from that equilibrium now. 10-year TIPS yields are negative. Surely one shouldn't expect real cash flow growth to be negative game iwin online. The market is clearly in disequilibrium, and besides, the equilibrium conditions don't apply when the Fed is deliberately bidding down the term premium.

tai avatar said...

You have to imagine that, when we get back to normal business cycle conditions (which will be associated with a rising risk free rate), the equity risk premium will move to new historic highs. But why would that be? I think rather that the historical correlation is due to factors that don't apply today.Bigone

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