Stock Market Fundamental Valuation and the Implied Equity Risk Premium

Abstract

This paper examines the empirical performance of a multi-stage growth model for the U.S., U.K., Netherlands stock markets during 1987-2010. This model uses analysts‟ forecasted earnings growth and ex-ante long-term real interest rates and outperforms the simple constant growth model but still requires a time-varying equity risk premium to explain major market movements. The implied equity risk premium is relatively stable during this period, with averages between 5 and 6 percent. A set of risk related explanatory variables explains the implied ERP up to 80 percent which suggests that the implied ERP is indeed a true risk premium and a valid missing link in explaining stock market movements.