By David Carruthers Posted on: The Equity Risk Premium ERP is a key component of every risk and return model in finance and reflects the price which investors place on equity risk.

The ERP will impact decisions as diverse as how superannuation funds invest their assets, to the price at which regulated monopolies can charge for their products.

Given the importance of the ERP to all actuaries, the sixth annual survey of the profession was undertaken in November As shown in Graph 1, this represents an increase over the average of 4. Investing in Australian shares provides many investors with franking credits, the value of which will vary depending on the tax rate of the investor. Without this allowance, the Australian ERP would have been 4.

The ERP for global developed market shares was generally slightly higher than for the Australian market. On average, respondents assumed that these markets would produce around 20bps more return than Australian shares after removing the allowance for franking credits.

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Emerging markets, which are typically viewed as more risky, were expected to produce a commensurately greater return to offset this higher risk. On average, the survey showed a 1.

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The ERP survey was undertaken in the days following the US election. Australian 10 year bond yields also rallied, rising by around 40bps in each of September and October. With this backdrop, we asked what the effect of a rise in either interest rates or inflation would have on the ERP estimate.

As the above results show, two-thirds of respondents do not expect an increase in interest rates to affect their estimate of the ERP. The remaining third would decrease their ERP estimate if rates rise. The results for an increase in inflation are more mixed.

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Again, most expect an increase in inflation to have no effect on the ERP. As one respondent noted, it may be depend on the cause of the rise of inflation.

Uses The importance of the ERP was highlighted in the responses as to how it is used. A total of 24 people completed the survey.

As such the results of the survey should not necessarily be taken as an indication of the results of the full profession. CPD Actuaries Institute Members can claim two CPD points for every hour of reading articles on Actuaries Digital.

David Carruthers has spent the last 20 years advising large investors on investment matters, both in Australia and the UK. In his current role he conducts research and provides advice in the area of retirement strategy and product development for superannuation funds. You must be logged in to post a comment.

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Share Twitter Share LinkedIn Share Facebook. Equity Risk Premium Survey By David Carruthers Posted on: This work is licensed under a Creative Commons Attribution-NonCommercial-No Derivatives CC BY-NC-ND Version 3.

About the author David Carruthers David Carruthers has spent the last 20 years advising large investors on investment matters, both in Australia and the UK.

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