CFAI end of chapter Q8. I got it wrong and even rereading the solution lots of times I don’t get it so any additional insight is most welcome.
Equity risk prem is the prem for holding risky assets necessary to incentivise investors from the risk free asset. Q8 asks about the effect of the inclusion of data from a volatile period on the equity risk premium.
If the return on the index with including the volatile period is (say) 8% and the risk free return is 3% then the equity risk prem is 5%. If the period of instability was not included in the index the return would be higher (say 9%) but then the equity risk prem is 6%. As such does the inclusion of ths date not increase the ERP rather than decrease it as in the CFAI solutions?