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The equity premium in finance and valuation textbooks

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  • Fernandez, Pablo

    (IESE Business School)

Abstract

This paper is a review of the recommendations about the equity premium found in the main finance and valuation textbooks. We review several editions of books written by authors such as Brealey and Myers; Copeland, Koller and Murrin (McKinsey); Ross, Westerfield and Jaffe; Bodie, Kane and Marcus; Damodaran; Copeland and Weston; Van Horne; Bodie and Merton; Stowe et al.; Pratt; Penman; Bruner; Weston & Brigham; and Arzac. We highlight the confusing message the textbooks convey regarding the equity premium and how it changes. The main confusion arises from not distinguishing among the four concepts that the term "equity premium" designates: Historical equity premium (HEP), Expected equity premium, Required equity premium (REP) and Implied equity premium (IEP). Some confusion also arises from not recognizing that although the HEP is equal for all investors, the REP, the EEP and the IEP are different for different investors. A unique IEP requires assuming homogeneous expectations for expected growth (g), but there are several pairs (IEP, g) that satisfy current prices. We claim that different investors have different REPs and that it is impossible to determine the REP for the market as a whole, because it does not exist.

Suggested Citation

  • Fernandez, Pablo, 2006. "The equity premium in finance and valuation textbooks," IESE Research Papers D/657, IESE Business School.
    • Handle: RePEc:ebg:iesewp:d-0657
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    File URL: http://www.iese.edu/research/pdfs/DI-0657-E.pdf
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    References listed on IDEAS

    as
    1. Fernandez, Pablo, 2006. "Equity premium: Historical, expected, required and implied," IESE Research Papers D/661, IESE Business School.
    2. Brown, Stephen J & Goetzmann, William N & Ross, Stephen A, 1995. "Survival," Journal of Finance, American Finance Association, vol. 50(3), pages 853-873, July.
    3. Merton H. Miller, 2000. "The History Of Finance: An Eyewitness Account," Journal of Applied Corporate Finance, Morgan Stanley, vol. 13(2), pages 8-14, June.
    4. repec:rus:hseeco:278562 is not listed on IDEAS
    5. Haitao Li & Yuewu Xu, 2002. "Survival Bias and the Equity Premium Puzzle," Journal of Finance, American Finance Association, vol. 57(5), pages 1981-1995, October.
    6. Philippe Jorion & William N. Goetzmann, 1999. "Global Stock Markets in the Twentieth Century," Journal of Finance, American Finance Association, vol. 54(3), pages 953-980, June.
    7. Fernandez, Pablo, 2004. "Shareholder value creation of microsoft and GE," IESE Research Papers D/564, IESE Business School.
    8. Fernandez, Pablo, 2002. "Valuation Methods and Shareholder Value Creation," Elsevier Monographs, Elsevier, edition 1, number 9780122538414.
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    Cited by:

    1. Fernandez, Pablo, 2008. "160 preguntas sobre finanzas," IESE Research Papers D/770, IESE Business School.

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    More about this item

    Keywords

    equity premium; equity premium puzzle; required market risk premium; historical market risk premium; expected market risk premium; risk premium; market risk premium; market premium;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • M21 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Economics - - - Business Economics

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