Measuring the equity risk premium with dividend discount models

Julio Gálvez ()
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Julio Gálvez: Banco de España

No 2207, Occasional Papers from Banco de España

Abstract: This paper assesses the estimation of the so-called equity risk premium, i.e. the expected return on equities in excess of the risk-free rate, using the dividend discount model as the organizing framework. I compare the equity risk premium estimates from different dividend discount models in terms of the in-sample and out-of-sample forecasting ability across different time horizons. Using data from the Eurostoxx 50 from 2001-2021, I find that equity risk premium estimates exhibit similar dynamics, and are elevated during periods of high uncertainty, such as the onset of the COVID-19 pandemic. Moreover, I find that the three-stage dividend discount model, which divides earnings growth into an extraordinary, transitional and steady-state phase, performs the best in terms of forecasting ability.

Keywords: expected returns; equity risk premium; dividend discount model; return predictability (search for similar items in EconPapers)
JEL-codes: G10 G12 G15 (search for similar items in EconPapers)
Pages: 28 pages
Date: 2022-05
New Economics Papers: this item is included in nep-rmg and nep-upt
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Persistent link: https://EconPapers.repec.org/RePEc:bde:opaper:2207

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