Another Estimate of the Equity Risk Premium

Canadian academics Glen Donaldson, Mark Kamstra and Lisa Kramer estimate that the equity risk premium (the amount equities should return over risk-free treasury bills) is about 3.5% on US equities (give or take 0.5%) in their November 2008 paper Estimating the Equity Premium, which is available for download at SSRN. They claim their estimate is more precise because of simultaneously considering dividend growth rates, interest rates, Sharpe ratios, price-dividend ratios, volatilities and excess returns.

As usual, in using this conclusion to plan and estimate future portfolio rates of return, one must consider the assumptions, and this study's validity is bounded by the use of data covering about the last 50 years of US experience and the presumption that the future will be like the past.

Compare these results to other estimates I've blogged about, all with higher numbers of 5% or more:

• the book review of Bradford Cornell's The Equity Risk Premium
• various others like the Canada Pension Plan Chief Actuary, Rick Ferri (author of AllAbout Asset Allocation) and the US Social Security Administration's Chief Actuary