TITLE:
Forward Looking Equity Risk Premium: A Normative Long-Term View
AUTHORS:
Gregory Moscato
KEYWORDS:
Equity Risk Premium, Discounted Cash Flows, Stock Market, Dividends, Share Buybacks
JOURNAL NAME:
Theoretical Economics Letters,
Vol.9 No.8,
December
26,
2019
ABSTRACT: We propose a Total Cash Flow present value model to
estimate the implied risk premium equity indices typically used in financial
models as proxies for the
aggregate stock market. Following a bottom-up approach, we use individual companies’ financial
information as well as analysts’ earnings estimates in order to reconstruct the
index total cash flow and expected future cash flows. Using the prices for
these indices, we then extract the implied Equity Risk Premia and analyze their evolution
through time. To illustrate our approach, we run our model over a period of 10
years surrounding the 2008 financial crisis on five stock indices, namely the S & P 500, the Euro Stoxx 50, the FTSE 100, the Hang Seng
Index and the TOPIX 100. We find
that our model is a conceptually robust approach to modeling long-term market Equity Risk
Premia and provides a normative view of expected returns for practitioners.