The equity premium in finance and valuation textbooks

Pablo Fernandez ()

No D/745, IESE Research Papers from IESE Business School

Abstract: This paper is a review of the recommendations about the equity premium found in the main finance and valuation textbooks. We review several editions of books written by authors such as Brealey and Myers; Copeland, Koller and Murrin (McKinsey); Ross, Westerfield and Jaffe; Bodie, Kane and Marcus; Damodaran; Copeland and Weston; Van Horne; Bodie and Merton; Stowe et al.; Pratt; Penman; Bruner; Weston & Brigham; and Arzac. We highlight the confusing message of the textbooks regarding the equity premium and its evolution. The main confusion arises from not distinguishing among the four concepts that the word equity premium designates: historical equity premium (hep), expected equity premium, required equity premium (rep) and implied equity premium (IEP). Some confusion also arises from not recognizing that although the HEP is the same for all investors, the REP, the EEP and the IEP are different for different investors. A unique IEP requires assuming homogeneous expectations for expected growth (g), but there are several pairs (IEP, g) that satisfy current prices. We claim that different investors have different REPs and that it is impossible to determine the REP for the market as a whole, because it does not exist.

Keywords: equity premium; equity premium puzzle; required market risk premium; historical market risk premium; expected market risk premium; risk premium; market risk premium; market premium (search for similar items in EconPapers)
JEL-codes: G12 G31 G32 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cfn and nep-upt
Date: 2008-04-20
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Related works:
Working Paper: The equity premium in finance and valuation textbooks (2006)
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