4 Evaluate – The ways of calculating ERP
While reading 'Estimating risk and return for an individual share', you found three ways to calculate the equity risk premium (ERP):
- using historical data and assuming that the past equity risk premium is a good indicator of the future ERP
- asking experts for their opinion of the future ERP
- estimating the implied future ERP from today’s stock market index value (using the dividend valuation model).
In the following three activities you will:
- identify and evaluate the ERP put forward by Professor Aswath Damodaran
- read ‘The new premium puzzle’, which highlights the challenges of arriving at an ERP
At the end of these activities, make notes on the advantages and disadvantages of the three methods used to arrive at an appropriate ERP.