Rethinking the Equity Risk Premium (a summary)

Yet, there is no general consensus on the size of the equity premium. The range of equity premium estimates published in influential textbooks is astonishingly wide, in recent years spanning between 3% and 10% per year. To get a better estimate, we were thus motivated to (1) look back and see what equity premium had been realized over a long historical period and (2) determine what adjustments, if any, need to be made to such a historical measure for use as a guide to the future. In the context of the capital asset pricing model of Sharpe (1964) and others, the equity premium posits a relationship between the amount of risk taken and the expected return of an asset or portfolio. In other words, the equity premium is the market price of risk. The current time frame, in which real (inflationadjusted) yields on long-term government bonds are essentially zero, is unusual in that the equity premium is essentially the only source of real returns on assets.