The Equity Risk Premium is Lower than You Think it is: Empirical Estimates from a New Approach

We offer ex ante estimates of the equity risk premium based on forecasted accounting numbers. Although our approach is isomorphic to dividend growth models, it generates various diagnostics that help to narrow the range of reasonable assumed growth rates. Our results, based on IBES consensus earnings forecasts over the 1985-1998 period, contrast sharply with those of prior research. Our estimates of risk premium are considerably lower than (about 3 percent) the estimates commonly cited (about 8 percent), and are also more stationary over time. This result has important implications both for academe (e.g., the equity premium puzzle) as well as practice (e.g., discount rates for valuation and over-valued stock markets).