The Equity Risk Premium In 2015 by SSRN

John R. Graham

Duke University; National Bureau of Economic Research (NBER)

Campbell R. Harvey

Duke University – Fuqua School of Business; National Bureau of Economic Research (NBER)

May 29, 2015

Abstract:

We analyze the history of the equity risk premium from surveys of U.S. Chief Financial Officers (CFOs) conducted every quarter from June 2000 to March 2015. The risk premium is the expected 10-year S&P 500 return relative to a 10-year U.S. Treasury bond yield. We show that the equity risk premium has increased more than 50 basis points from the levels observed in 2014. The current 10-year risk premium is 4.51%. Similarly, measures of risk such as investor disagreement and perceptions of volatility have increased. Interestingly, the increased premium and risk are not reflected in market-based measures of risk, such as the VIX and credit spreads. We also link our survey results to measures survey-based measures of the weighted average cost of capital and investment hurdle rates. The hurdle rates are significantly higher than the cost of capital implied by the market risk premium.

The Equity Risk Premium In 2015 – Introduction

We analyze the results of the most recent survey of Chief Financial Officers (CFOs) conducted by Duke University and CFO Magazine. The survey closed on March 3, 2015 and measures expectations beginning in the first quarter of 2015. In particular, we poll CFOs about their long-term expected return on the S&P 500. Given the current U.S. 10?year Treasury bond yield, we provide estimates of the equity risk premium and show how the premium changes through time. We also provide information on the disagreement over the risk premium as well as average confidence intervals. Finally, we link the equity risk premium to measures used to evaluate firm’s investments: the weighted average cost of capital (WACC) and the investment hurdle rate.

1. Method

2.1 Design

The quarterly survey of CFOs was initiated in the third quarter of 1996.1 Every quarter, Duke University polls financial officers with a short survey on important topical issues (Graham and Harvey, 2009). The usual response rate for the quarterly survey is 5%?8%. Starting in June of 2000, a question on expected stock market returns was added to the survey. Fig. 1 summarizes the results from the risk premium question. While the survey asks for both the one?year and ten-year expected returns, we focus on the ten?year expected returns herein, as a proxy for the market risk premium.

The executives have the job title of CFO, Chief Accounting Officer, Treasurer, Assistant Treasurer, Controller, Assistant Controller, or Vice President (VP), Senior VP or Executive VP of Finance. Given that the overwhelming majority of survey respondents hold the CFO title, for simplicity we refer to the entire group as CFOs.

Equity Risk Premium

2.2 Delivery and response

In the early years of the survey, the surveys were faxed to executives. The delivery mechanism was changed to the Internet starting with the December 4, 2001 survey. Respondents are given four business days to fill out the survey, and then a reminder is sent allowing another four days. Usually, two?thirds of the surveys are returned within two business days.

The response rate of 5?8% could potentially lead to a non?response bias. There are five reasons why we are not overly concerned with the response rate. First, we do not manage our email list. If we deleted the email addresses that had not responded to the survey in the past 12 quarters, our response rate would be in the 15?20% range – which is a good response rate. Second, Graham and Harvey (2001) conduct a standard test for non?response biases (which involves comparing the results of those that fill out the survey early to the ones that fill it out late) and find no evidence of bias. Third, Brav, Graham, Harvey and Michaely (2005) conduct a captured sample survey at a national conference in addition to an Internet survey. The captured survey responses (to which over two?thirds participated) are qualitatively identical to those for the Internet survey (to which 8% responded), indicating that non?response bias does not significantly affect their results. Fourth, Brav et al. contrast survey responses to archival data from Compustat and find archival evidence for the universe of Compustat firms that is consistent with the responses from the survey sample. Fifth, Campello, Graham, and Harvey (2011) show that the December 2008 response sample is fairly representative of the firms included in the commonly used Compustat database.

Equity Risk Premium

Equity Risk Premium

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