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The Equity Risk Premium in Developed Capital Markets: Starting Signal for a New Modesty?

Authors:

Leonhard KNOLL, Jan HÖCKER

Abstract:

Motivated by a recent report of Deutsche Bank, we argue that equity risk premia for developed capital markets as used in many valuations are too high. We draw upon historical data, theoretical considerations and last but not least common sense. Our main arguments concern shortcomings in the estimation of historical market risk premia and the importance of the relative risk premium. While there is currently no better approach to calculate risk premia other than historical rates of return, one has to apply great diligence since results might be distorted. We present different reasons as to why this is likely to be the case. Based on the importance of the relative risk premium and considering the influence of the duration of cash-flow series, we show that a small growth in cash flow makes relative risk premia that correspond with often used absolute market risk premia even less plausible. In our opinion, measurement problems of historic risk premia and the effect of their relative magnitude compared to the riskless rate of return give no leeway for continuing “business as usual”.
 
 
 
 

Journal information

  • Edited by: IROVAL under ANEVAR guidance
  • ISSN: 1842-3787
  • Frequency: bi-annual
  • Current Volume: 12 (2), 2017
 
 
 
 
 

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