Abstract
Are you aware of recent research questioning the use of those realized equity premiums as an estimate of the equity risk premium (ERP)? 1,2 Or do you simply choose to ignore the research? ERP is a forward-looking concept. ERP is an expectation as of the valuation date for which no ‘‘market quotes’’ are observable. While you can observe premiums realized over time by referring to historical data, such calculated premiums serve only as estimates for the expected ERP. If we are to truly mimic the market, then our goal should be to estimate the true expected ERP as of the valuation date. To do that you need to look beyond the realized premiums. While there is no one universally accepted standard for estimating ERP, you need to be aware of recent research and not blindly continue using the historical realized equity premiums reported in the SBBI Yearbook. The methods used can be broadly categorized into one of two approaches: the Realized Return or ex post approach and the Forward-looking or ex ante approach.
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