What Number for the Equity Risk Premium?

I’ve often said that the equity risk premium is probably a lot lower than most people realize. This is the amount that investors pay to own stocks over the risk-free rate of Treasury bills.

Some academics decided to do a broad survey to see what others think:

US Market Risk Premium Used in 2011 by Professors, Analysts and Companies: A Survey with 5.731 Answers

The average Market Risk Premium (MRP) used in 2011 by professors for the USA (5.7%) is higher than the one used by analysts (5.0%) and companies (5.6%). The standard deviation of the MRP used in 2011 by analysts (1.1%) is lower than the ones of companies (2.0%) and professors (1.6%). Most previous surveys have been interested in the Expected MRP, but this survey asks about the Required MRP. The paper also contains the references used to justify the MRP, comments from 58 persons that do not use MRP, and comments of 110 that do use MRP. The comments illustrate the various interpretations of the required MRP and its usefulness.

Professors, analysts and companies that cite Ibbotson as their reference use MRP for USA between 2% and 14.5%, and the ones that cite Damodaran as their reference use MRP between 2% and 10.8%.

Wow, the professors think it’s 5.7%! That’s quite high — and it’s down from 6% in 2010.

My preference is to see what investors demand to own stocks over long-term Treasuries, and I think that’s probably around 1.5% to 2%.

Posted by on April 14th, 2011 at 12:11 pm

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