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Determinants of the Implied Equity Risk Premium in Brazil

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  • Sanvicente, Antonio Zoratto
  • Carvalho, Mauricio Rocha Alves de

Abstract

This paper proposes and tests market determinants of the equity risk premium (ERP) in Brazil. We use implied ERP, based on the Elton (1999) critique. The ultimate goal of this exercise is to demonstrate that the calculation of implied, as opposed to historical ERP makes sense, because it varies, in the expected direction, with changes in fundamental market indicators. The ERP for Brazil is calculated as a mean of large samples of individual stock prices in each month in the January, 1995 to September, 2015 period, using the 'implied risk premium' approach. As determinants of changes in the ERP we obtain, as significant, and in the expected direction: changes in the CDI rate, in the country debt risk spread, in the US market liquidity premium and in the level of the S&P500. The influence of the proposed determining factors is tested with the use of time series regression analysis. The possibility of a change in that relationship with the 2008 crisis was also tested, and the results indicate that the global financial crisis had no significant impact on the nature of the relationship between the ERP and its determining factors. For comparison purposes, we also consider the same variables as determinants of the ERP calculated with average historical returns, as is common in professional practice. First, the constructed series does not exhibit any relationship to known market-events. Second, the variables found to be significantly associated with historical ERP do not exhibit any intuitive relationship with compensation for market risk.
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  • Sanvicente, Antonio Zoratto & Carvalho, Mauricio Rocha Alves de, 2012. "Determinants of the Implied Equity Risk Premium in Brazil," Insper Working Papers wpe_281, Insper Working Paper, Insper Instituto de Ensino e Pesquisa.
    • Handle: RePEc:ibm:ibmecp:wpe_281
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    References listed on IDEAS

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    1. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
    2. Ľuboš Pástor & Meenakshi Sinha & Bhaskaran Swaminathan, 2008. "Estimating the Intertemporal Risk–Return Tradeoff Using the Implied Cost of Capital," Journal of Finance, American Finance Association, vol. 63(6), pages 2859-2897, December.
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    4. Sanvicente, Antonio Z., 2008. "A Relevância de Prêmios por Risco Soberano e Risco Cambial no Uso do CAPM para a Estimação do Custo de Capital das Empresas," Insper Working Papers wpe_131, Insper Working Paper, Insper Instituto de Ensino e Pesquisa.
    5. Edwin J. Elton, 1999. "Presidential Address: Expected Return, Realized Return, and Asset Pricing Tests," Journal of Finance, American Finance Association, vol. 54(4), pages 1199-1220, August.
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    7. William R. Gebhardt & Charles M. C. Lee & Bhaskaran Swaminathan, 2001. "Toward an Implied Cost of Capital," Journal of Accounting Research, Wiley Blackwell, vol. 39(1), pages 135-176, June.
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    Cited by:

    1. Guanais, Luiz Felipe Poli & Sanvicente, Antonio Zoratto & Sheng, Hsia Hua, 2017. "Cost of equity estimation for the Brazilian market: a test of the Goldman Sachs model," Textos para discussão 447, FGV EESP - Escola de Economia de São Paulo, Fundação Getulio Vargas (Brazil).
    2. Alexandre de Carvalho & Thiago Trafane Oliveira Santos, 2020. "Is the Equity Risk Premium Compressed in Brazil?," Working Papers Series 527, Central Bank of Brazil, Research Department.

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