The Long-Run Equity Risk Premium

This paper introduces two risk factors which are the covariance between long-run consumption growth and cash flows and the duration of cash flow, and investigates how these factors serve to explain the KOSPI return risk premiums. Based on our empirical results comparing the proposed two-factor cash flow model with the standard benchmark models such as CAPM and Fama-French 3-factor model (FF-3F), using KOSPI equity including de-listed stocks, the cash flow model explains 74.7% of the cross-section of equity risk premium while CAPM and FF-3F model explains 41.9% and 64.1% to the maximum, respectively, showing that the cash-flow model is superior in explaining the risk premium factor structure compared with the benchmark models. Also, the pricing error is only 4% in the two-factor cash flow model, while CAPM and FF-3F are 7.7% and 4.7%, respectively, indicating the cash flow model outperforms the standard benchmark models in pricing error as well. These results can be interpreted that the cross section of the equity risk premium is related to a firm’s cash flow and long-run consumption, and therefore the growth rate of consumption in the long run rather than contemporaneous consumption growth rate has a greater influence on the determination of the risk premium.

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The long-run equity risk premium

Finance Research Letters ◽

10.1016/j.frl.2005.08.003 ◽

2005 ◽

Vol 2 (4) ◽

pp. 185-194 ◽

Cited By ~ 45

Author(s):

John R. Graham ◽

Campbell R. Harvey

Keyword(s):

Risk Premium ◽

Equity Risk Premium ◽

Equity Risk ◽

Long Run

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Corporate control rights and the long-run equity risk premium

Journal of International Financial Markets Institutions and Money ◽

10.1016/j.intfin.2007.08.007 ◽

2009 ◽

Vol 19 (1) ◽

pp. 63-76

Author(s):

Roelof Salomons ◽

Elmer Sterken

Keyword(s):

Risk Premium ◽

Corporate Control ◽

Equity Risk Premium ◽

Control Rights ◽

Equity Risk ◽

Long Run

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The historically realised equity risk premium as a guide to future expectations in an emerging market: The case of South Africa

Journal of Economic and Financial Sciences ◽

10.4102/jef.v2i1.361 ◽

2008 ◽

Vol 2 (1) ◽

pp. 89-104

Author(s):

Jesse De Beer

Keyword(s):

Risk Premium ◽

Emerging Market ◽

Equity Risk Premium ◽

Future Expectations ◽

Investment Performance ◽

Equity Risk ◽

Ex Post ◽

Long Run ◽

Ex Ante

The concept of an equity risk premium (ERP) is fundamental to modern financial theory and central to every decision at the heart of corporate finance. Efforts to quantify ERP are well rewarded by insights into the stability and dynamics of long-term investment performance. Such efforts require the quantification of both historically realised (ex post) and expected future (ex ante) premiums. Finding an appropriate proxy for the expected (ex ante) ERP remains a challenging aspect. One widely used application is the use of long-term averages of observed market premiums as a proxy for expected returns. The aim of this paper is to analyse the appropriateness of the historical methodology of estimating expected ERP in the South African context. The analysis in this paper suggests that analysing past historical figures remains useful in the SA context. This is supported by the results of the statistical analysis, showing stationarity of the ERP time-series, meaning that the true mean does not change over time. This implies that the historical average mean may be used as a proxy for the long-run expected ERP. However, the well-documented problems relating to large standard errors (predictability problem) and relevance due to changing circumstances are also evident in the SA data. Thus, investors would be well advised to analyse the past and apply informed judgments as to future differences, if any, when attempting to arrive at fair forecasts.

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What Explains The Equity Risk Premium In ASEAN Countries?

Journal of Applied Business Research (JABR) ◽

10.19030/jabr.v32i6.9818 ◽

2016 ◽

Vol 32 (6) ◽

pp. 1707

Author(s):

Soo-Hyun Kim ◽

Katherine Villalobos

Keyword(s):

Error Correction ◽

Risk Premium ◽

Fixed Effects ◽

Correction Term ◽

Equity Risk Premium ◽

Macroeconomic Variables ◽

Asean Member ◽

Equity Risk ◽

Long Run ◽

The Impact

This paper aims to mainly investigate the impact of the selected macroeconomic variables such as inflation (INF), gross domestic product (GDP), foreign direct investment (FDI) and stocks traded turn-over ratio (STTR) on equity risk premium (ERP) of six major ASEAN member countries such as Indonesia, Malaysia, Philippines, Singapore, Thailand and Vietnam. Applied methods are panel pooled regression and panel vector error correction model (VECM) through the latest version of Eviews9. In the former approach, among the selected macroeconomic variables, both INF and STTR significantly and positively affect the ERP. Both periods and years show to have fixed effects as dummy variables. One cointegration has been determined among macroeconomic variables and ERP suggesting a long term equilibrium association which led to employ Panel VECM. INF denotes a significant long-run relationship with ERP and the error correction term results suggest deviation of INF is a relevant factor but not the errors of liquidity as the STTR didn't show any significant impact in the model. Granger Casuality test suggests both INF and ERP do granger causes each other in the short run. Thus, inflation is a robust factor of ERP in two different methods while the STTR is not a robust as it shows different results.

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