GGM equity risk premium = (1-year forecasted dividend yield on market index) + (consensus long-term earnings growth rate) − (long-term government bond yield)
Macroeconomic model estimates
equity risk premium = [1+ˆi]×[1+ˆrEg]×[1+ˆPEg]−1+ˆY−ˆRF
i= expected inflation
ˆrEg= expected real growth in EPS
ˆPEg= expected changes in the P/E ratio
ˆY= the expected yield on the index
ˆRF= the expected risk-free rate
i = [(1 + YTM of 20-year T-bonds) ÷ (1 + YTM of 20-year TIPS)] – 1
ˆrEg= real GDP growth
ˆrEg= labor productivity growth rate + labor supply growth rate
capital asset pricing model (CAPM)
required return on stock j = risk-free rate + (equity risk premium × beta of j)
Multifactor Models
required return = RF + (risk premium)1 + (risk premium)2 + … + (risk premium)n
(risk premium)i = (factor sensitivity)i × (factor risk premium)i
Fama-French Model
required return of stock j = RF + βmkt,j × (Rmkt − RF) + βSMB,j × (Rsmall − Rbig) + βHML,j × (RHBM − RLBM)
Macroeconomic Multifactor Models
confidence risk×β
time horizon risk×β
inflation risk×β
business cycle risk×β
market timing risk×β
Build-Up Method
required return = RF + equity risk premium + size premium + specific-company premium
