Info

8.43%

6.68%

4.87%

3.57%

Note that the premiums can range from 3.57% to 8.43%, depending upon the choices made. In fact, these differences are exacerbated by the fact that many risk premiums that are in use today were estimated using historical data three, four or even ten years ago. If we follow the propositions about picking a long-term geometric average premium over the long term treasury bond rate, the historical risk premium that makes the most sense is 4.82%.

Historical Premiums in other markets

While historical data on stock returns is easily available and accessible in the United States, it is much more difficult to get this data for foreign markets. The most detailed look at these returns estimated the returns you would have earned on 14 equity markets between 1900 and 2001 and compared these returns with those you would have earned investing in bonds.12 Figure 4.1 presents the risk premiums - i.e., the additional returns - earned by investing in equity over treasury bills and bonds over that period in each of the 14 markets:

12 Dimson, E., P. March and M. Staunton, 2002, Triumph of the Optimists, Princeton University Prsss.

Figure 4.1: Equity Risk Premiums - By Country

Data from Dimson et al. The differences in compounded annual returns between stocks and short term governments/ long term governments is reported for each country. While equity returns were higher than what you would have earned investing in government bonds or bills in each of the countries examined, there are wide differences across countries. If you had invested in Spain, for instance, you would have earned only 3% over government bills and 2% over government bonds on an annual basis by investing in equities. In France, in contrast, the corresponding numbers would have been 7.1% and 4.6%. Looking at 40-year or 50-year periods, therefore, it is entirely possible that equity returns can lag bond or bill returns, at least in some equity markets. In other words, the notion that stocks always win in the long term is not only dangerous but does not make sense. If stocks always beat riskless investments in the long term, stocks should be riskless to an investor with a long time horizon.

-ftr

Money Mogul

Money Mogul

Get All The Support And Guidance You Need To Be A Success At Being A Money Mogul. This Book Is One Of The Most Valuable Resources In The World When It Comes To How to Maintain the Pledge to Fix Your Finances from Your New Year’s Resolution.

Get My Free Ebook


Post a comment