Ex-post and ex-ante estimation of market risk premium
In the financial world, stocks should provide a greater return than safe investments such as Treasury bonds. This is due to a higher risk involved when obtaining stocks in comparison to treasury bonds. Thus, the higher risk involved, the higher return is expected by the investors. The return expected over the risk-free rate is a compensation for the risk. This compensation is referred to as the market risk premium (MRP).According to financial researchers, it is not only the magnitude of the MRP discussed controversially among economists, but also the appropriate methodology to calculate meaning-ful estimates. The various estimation methods can be generalized as the historical approach (ex post) and the forward-looking approach (ex ante).The purpose of this thesis is to investigate the application of the estimation methods for-practical investment decitions and to observe which estimate (ex-post or/and ex-ante) the financial actors find to be optimal as an input for decision making.Data will be gathered from a small group of respondents in order to receive an in-depth comprehension of the subject matter. Hence, the nature of the data in this research dictates the application of qualitative methods.It can be concluded that both the ex-ante method and the ex-post method are used by the three financial actors when forecasting the MRP. Furthermore, it could be concluded that investors can apply different values of MRP as an input for models and investment deci-sions due to the fact that the choice of the fair MRP involves some subjective judgments from the individual analyst or investor.
School:Högskolan i Jönköping
Source Type:Master's Thesis
Keywords:risk premium ex post ante estimation
Date of Publication:03/15/2006