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Equity Premium

In: Financial Markets Efficiency and Economic Behaviour

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  • Gian Maria Tomat

    (Bank of Italy)

Abstract

The equity premium is the excess rate of return of stocks over the riskless rate. The assumption of log-normality for gross asset returns implies, that the conditional expected excess rate of return is equal to the opposite of the covariance between the natural logarithm of the stochastic discount and the stock rate of return. The Sharpe ratio, modelled as the ratio between the expected excess rate of return and its standard deviation, defines a volatility bound for the stochastic discount factor. The monthly real excess return has been equal on average to 8.8 per cent at a yearly rate in a panel of 403 stocks for the five largest Euro area economies in the 2012m02–2015m06 sample period and its standard deviation is about ten times as large. Further estimates of the volatility bound can be obtained from the within and between components and provide evidence on the completeness of financial markets. The capital asset pricing model relates the excess return of stocks over the riskless rate to the excess return of the market portfolio.

Suggested Citation

  • Gian Maria Tomat, 2023. "Equity Premium," Palgrave Macmillan Studies in Banking and Financial Institutions, in: Financial Markets Efficiency and Economic Behaviour, chapter 0, pages 25-42, Palgrave Macmillan.
    • Handle: RePEc:pal:pmschp:978-3-031-36836-3_3
    DOI: 10.1007/978-3-031-36836-3_3
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