Singer-T… model is a version of international CAPM. The application is to calculate risk premia: RP[i] = sigma[i] * RP[m]/sigma[m] = sigma[i] * Sharpe ratio of the market Here RP[i] is the risk premium of an asset or asset class i sigma[i] is its standard deviation RP[m] is the risk premium for a globally diversified market portfolio sigma[m] is its standard deviation
CFAAtlanta, It’s RiskPremimum = Standard Deviation * Correlation * (Risk Premimum/Standard Deviation of the market) looks like you missed the correlation part.
Yes… darn it… In any case, it is basically the CAPM equation rewritten with beta written in terms of the standard deviations and correlation.
Hmm… going through some old posts… and this question caught my eye. If someone under-estimates the Equity Risk Premium. The expected return as per CAPM would be lower and hence even at the individual stock level, rather than portfolio level, wouldn’t there be an underallocation to the stock just as there would be for the portfolio? Also, wouldn’t that lead to a surprise in the future where the actual stock return would plot above the SML. For example, people underestimated the equity risk premium and it’s like that as a result, the actual performance of the stock will come in higher than expected leading to a surprise to the upside?
I think the stock would underperform in the future. If you originally underestimated the equity risk premium you would have a lower k in the simple equation: V = D1/k-g and thus a higher value…meaning that when the ER p was propoerly implemented you’d realize the stock was not worth as much as you thought and the surprise would be negative.