How Low is the Equity Risk Premium? Evidence from Imputed Earnings Forecasts

Abstract

The U.S. equity risk premium using historical estimates of stocks and bonds is 6 to 8 percent. However, research has suggested that the risk premium should be much lower. An important stream of literature in this respect is using analysts’ earnings forecasts and reverse engineering the residual income valuation model to impute risk premium. The use of analysts’ earnings forecasts leads to an upward bias of the estimated risk premium. In this study, we implement methodology to measure equity risk premium without using analysts’ earnings forecasts. Our results provide evidence supporting a close to zero risk premium.