Hi all, I was wondering if some one can help me with this question. How in practice is this done. Many thanks S
What is equity premium? I only know risk premium
equity premium: The excess return that an individual stock or the overall stock market provides over a risk-free rate. risk premium: The return in excess of the risk-free rate of return that an investment is expected to yield
is the equity premium ever measured vs the commercial bond as opposed to a risk free bond?
I only focus on Canadian equities because we out-manage the rest, but my own eye-ball of the ERP is calculated in the following manner. I assume that equities are long-lived assets so I start off by taking the yield on the 5-Year Canada and then adding on enough risk to comp. me for the holding period and risk the clients will have to stomach. So let’s say the 5-year Avg. is around 3.3 to 3.5. I then take the 115+ or so S&P/TSX Industry groups and study the 3 and 5 year standard deviations from a high level and downside risk on the low side. From that I apply a quasi iterative process towards adding on additional basis points for the risk involved in taking on a position within a group. Ultimiately, the choice for individual stocks is driven more by valuations. For example I try to avoid paying more than about 24 times earnings for anything. But back to the ERP question…based on some analysis, some anecdotal evidence and, quite truthfully, some instinct/gut feeling…I’ll happily add on 250 to 500 more basis points. Willy