Session 5: Equity Risk Premiums

(I apologize for the screen sharing snafu, which is about 12 minutes, between minutes 10 and 22 of the class, since you watch an awfully low res video of me in front of the classroom). In the session today, we started by doing a brief test on country risk premiums. We started with an assessment of historical equity risk premiums, and why they are not good predictors of future equity risk premiums, before embarking on a discussion of country risk and how to deal with it, and measure it. We also looked at company risk exposure to country risk, with my core argument being that a company’s exposure to country risk comes from where it dos business, not where it is incorporated:After a brief foray into lambda, a more composite way of measuring country risk, we spent the rest of the session talking about the dynamics of implied equity risk premiums and what makes them go up, down or stay unchanged. We then moved to cross market comparisons, first by comparing the ERP to bond default spreads, then bringing in real estate risk premiums and then extending the concept to comparing ERPs across countries. Finally, I made the argument that you should not stray too far from the current implied premium, when valuing individual companies, because doing so will make your end valuation a function of what you think about the market and the company. If you have strong views on the market being over valued or under valued, it is best to separate it from your company valuation. I am attaching the excel spreadsheet that I used to compute the implied ERP at the start of February 2023. Play with it when you get a chance. Post class test and solution attached. Until next time!Start of the class test: https://www.stern.nyu.edu/~adamodar/pdfiles/eqnotes/tests/ImplPrem.pdfERP for February 2023: https://pages.stern.nyu.edu/~adamodar/pc/implprem/ERPFeb23.xlsxSlides: https://www.stern.nyu.edu/~adamodar/podcasts/valspr23/session5slides.pdfPost class test: https://www.stern.nyu.edu/~adamodar/pdfiles/eqnotes/postclass/session5Atest.pdfPost class test solution: https://www.stern.nyu.edu/~adamodar/pdfiles/eqnotes/postclass/session5Asoln.pdf