Risk premium of the market (market spread) Risk Premium for a mature market? Broadening the sample By Country Average Risk Premia如温m的m=4 fIIE 日西o
Risk premium of the market (market spread)
Implied premiums Implied Equity Premiums If we assume that stocks are correctly priced in the aggregate and we can estimate the expected cashflows from buying stocks, we can estimate the expected rate of return on stocks by computing an internal rate of return. Subtracting out the riskfree rate should yield an implied equity risk premium. This implied equity premium is a forward looking number and can be updated as often as you want(every minute of every day, if you are so
Implied premiums
Calculation example Implied equity Premium for the s&P 500: January 1, 2004 We can use the information in stock prices to back out how risk averse the market is and how much of a nsk premium it is demanding After year 5, we will assume that In 2003. dividends stock earnings on the index will grow at buybacks were 2.81%o of Analysts expect earnings to grow 9.5% a year for the next 5 years as 4.25%6, the same rate as the entire the index, generating 31.29 the economy comes out of a recession. im cashflows 34.26 3752 4108 January 1, 2004 S&p 500 is at 1111 91 If you pay the current level of the index, you can expect to make a retum of 7.94%o on stocks(whi is obtained by solving for r in the following equation 111191= 3426.3752.410844.984926492600425) a+n)a+r)2a+r)3a+r)4a+r)°(-0425)+r)5 Implied Equity risk premium=Expected retum on stocks- Treasury bond rate=7.94%6-4.25%
Calculation example…
Market spread(rm-Rf over time Implied Premiums in the US so 3os ^人
Market spread (Rm-Rf) over time…
Taxes on capital gains and dividends Effect of Changing t ax status of dividends on Stock Prices- January 2003 Expected Return on Stocks (Implied)in Jan 2003 7.91% Dividend Yield in January 2003 2.00% Assuming that dividends were taxed at 30%(on average)on 1/1/03 and that capital gains were taxed at 15% After-tax expected return on stocks=2%(1-3)+5.91%(1-15)=6.42% a If the tax rate on dividends drops to 15% and the after-tax expected return remains the same 2%(1-.15)+X%(1-.15)=642% New Pre-tax required rate of return=7.56% New equity risk premium=3.75% Value of the s&P 500 at new equity risk premium=965.11 Expected Increase in index due to dividend tax change=9.69%
Taxes on capital gains and dividends