Here is an extract from Equity Asset Valuation (Jerald Pinto)
“An investor is ultimately concerned with returns and volatility stated in terms of his own
currency. Historical returns are often available or can be constructed in local currency and
home currency terms. Equity risk premium estimates in home currency terms can be higher
or lower than estimates in local currency terms because exchange rate gains and losses from
the equity component are generally not exactly offset by gains and losses from the government
security component of the equity risk premium. For example, the arithmetic mean UK
premium over 1970 to 2005 was 6.58 percent in pound sterling terms but for a U.S. investor
it was 5.54 percent (Morningstar 2007, 176). The U.S. dollar estimate more accurately
refl ects a U.S. investor ’ s historical experience. A sound approach for any investor is to focus
on the local currency record, incorporating any exchange rate forecasts.”
Didn’t quite understand what the author meant here when he says
“Equity risk premium estimates in home currency terms can be higher or lower than estimates in local currency terms because exchange rate gains and losses from the equity component are generally not exactly offset by gains and losses from the government security component of the equity risk premium.”
Broadly I understand ERP is stated for each country’s equity asset class. So naturally, ERP for India would be in INR (based on Bombay Stock Exchange Index) and UK’ ERP would be based on pound sterling (FTSE). But I don’t understand what the author was trying to unravel.