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Title:The Implied Equity Risk Premium: An Evaluation of Empirical Methods PDF Logo
Authors:Schröder, David
Issue Date:2005
Series/Report no.:Bonn econ discussion papers 2005,13
Abstract:A new approach of estimating a forward-looking equity risk premium (ERP) is to calculate the implied risk premium using present value (PV) formulas. This paper compares implied risk premia obtained from different PV models and evaluates them by analyzing their underlying firmspecific cost-of-capital estimates. It is shown that specific versions of dividend discount models (DDM) and residual income models (RIM) lead to similar ERP estimates. However, the results of cross-sectional regression tests of individual firm risk suggest that there are qualitative differences between both approaches. Expected firm risk obtained from the DDM is more in line with standard asset pricing models and performs better in predicting future stock returns than estimates from the RIM.
Subjects:equity risk premium
cost of capital
expected stock returns
JEL:G12
Document Type:Working Paper
Appears in Collections:Bonn Econ Discussion Papers, Bonn Graduate School of Economics (BGSE), Universität Bonn

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