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The Equity Risk Premium: Empirical Evidence from Emerging Markets

Michael Donadelli and Lorenzo Prosperi

No 1201, Working Papers CASMEF from Dipartimento di Economia e Finanza, LUISS Guido Carli

Abstract: The analysis of the Equity Risk Premium (ERP) and the research efforts aimed at solving the Equity Premium Puzzle (Mehra and Prescott 1985), are still widely discussed in the economic and financial literature. The purpose of this paper is to show that differences in the ERP between developed and emerging markets lead to many empirical asset pricing issues. Using data from both markets, we first provide an ex-post simple time series analysis on the ERP. Compared to developed markets, and in line with existing literature, we find that emerging markets compensate investors with higher returns. We observe that the time varying nature of the ERP in emerging economies, relates mainly to economic cycles, shocks and other macro phenomena (i.e. global financial market integration). Basic statistics also show that during the last decade the ERP shrunk, especially in advanced economies. To improve investigations on the higher emerging marketsÕ equity premium, a standard global asset pricing model is adopted. On one hand, we mainly find that the one-factor model does not fully predict emerging marketsÕ equity premia. On the other hand, we discover that the inclusion of liquidity conditions and time-varying components provides reasonable explainations for the behaviour of equity premia in these ÒyoungÓ markets. Our final findings mainly suggests that global business cycle and financial integration process are crucial in determining the risk associated to emerging marketsÕ investments.

Keywords: Stock markets returns; equity premium puzzle; Equity risk premium. (search for similar items in EconPapers)
JEL-codes: C13 E44 G12 G15 (search for similar items in EconPapers)
Date: 2012
New Economics Papers: this item is included in nep-cwa, nep-fmk and nep-ifn
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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