Risk and Return models for Equity Markets and Implied Equity Risk\n Premium

Equity risk premium is a central component of every risk and return model in\nfinance and a key input to estimate costs of equity and capital in both\ncorporate finance and valuation. An article by Damodaran examines three broad\napproaches for estimating the equity risk premium. The first is survey based,\nit consists in asking common investors or big players like pension fund\nmanagers what they require as a premium to invest in equity. The second is to\nlook at the premia earned historically by investing in stocks, as opposed to\nrisk-free investments. The third method tries to extrapolate a market-consensus\non equity risk premium (Implied Equity Risk Premium) by analysing equity prices\non the market today. After having introduced some basic concepts and models,\nI'll briefly explain the pluses and minuses of the first two methods, and\nanalyse more deeply the third. In the end I'll show the results of my\nestimation of ERP on real data, using variants of the Implied ERP (third)\nmethod.\n