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The equity premium puzzle addresses the difficulty in understanding and explaining this disparity. [1] This disparity is calculated using the equity risk premium: The equity risk premium is equal to the difference between equity returns and returns from government bonds. It is equal to around 5% to 8% in the United States. [2]
The risk premium is used extensively in finance in areas such as asset pricing, portfolio allocation and risk management. [2] Two fundamental aspects of finance, being equity and debt instruments, require the use and interpretation of associated risk premiums with the inputs for each explained below:
The level of risk is closely proportional to the equity risk premium. The wider the difference between the stock's return and the risk-free rate, and thus the higher the premium, the higher the risk. The equity risk premium can also be used as a portfolio indicator by investors. According to Gaurav Doshi, CEO of IIFL Wealth Portfolio Managers ...
Risk premium is the added return that investors expect to earn from an asset such as a share of stock that carries more risk than another asset such as a high-grade corporate bond. The risk ...
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Typically, that spread––known as the equity risk premium, or ERP––averages around 3.5 points. So the best estimate of the return investors expect from stocks going forward is 5.9%, which ...
Grinold, Kroner, and Siegel (2011) estimated the inputs to the Grinold and Kroner model and arrived at a then-current equity risk premium estimate between 3.5% and 4%. [2] The equity risk premium is the difference between the expected total return on a capitalization-weighted stock market index and the yield on a riskless government bond (in ...
Much of the equity premium puzzle can be explained by the rare disaster scenarios proposed by Barro and Rietz. The basic reasoning is that if people are aware that rare disasters (i.e. the Great Depression or World War I and World War II) may occur, but the disaster never occurs during their lives, then the equity premium will appear high.