ESTIMATING EQUITY RISK PREMIUM: THE CASE OF GREATER CHINA

Abstract

The expected equity risk premium is a key input of many asset prcing models in nance. There exist a number of methods to estimate the risk premium. It is also well documented that the risk premium is time-varying. This paper briey reviews two di¤erent approaches. More specically, the historical average and relative estimation are taken into closer examination. The rst approach is applied to estimate equity risk premium for stock markets in Greater China when the stock markets were recovering from the bottom. Then the relative estimation approach is also adopted to empirical data to justify the ndings in the rst one, which takes into consideration the lower required rate of return for Chinese investors due to lack of investment opportunities.
After making these adjustments, we nd that risk premium in mainland China is close to risk premium for Hong Kong and Taiwan markets. All of those markets have higher risk premium compared to US market. The risk premium for Shanghai and Shenzhen market are about 8% and 10% respectively. For Hong Kong and Taiwan these numbers become 8% and 9%, where the long-term forward-looking risk premium for US market is about 4%.