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You need access to an SBBI yearbook. Depending on your purposes, use the 20-year treasury as of today, or a normalized rate. I think ERP is around 6%
Stupid Question (DCF) (Originally Posted: 04/23/2009)
where do people usually get market risk premium (return on mkt - risk free rate)? I know a lot of people use 10-yr t-bond rate for risk free rate, but how do ppl get return on mkt? I assume average return of comparables..? but what exact "return" do people talk about when they talk about avg. return of comparables?
Historical excess returns of a value-weighted index like S&P 500 minus historical performance of 10-yr treasuries.
You actually use the current 10-yr tresury yield, not the historical.
In LatAm: I've seen ppl use the current or some kind of average when it comes to 10Y T-Notes on the RF rate.
When it comes to market premium, the usual is to use a value between 4% and 7%. I'm not sure if using the "Historical excess returns of a value-weighted index like S&P 500 minus historical performance of 10-yr treasuries." is such a good idea in bear markets like this one.(Because it's like -20%)
Same thing goes for the Betas(WAY too much volatility).
I'm not sure how it's done in the US.
Valuation is not a trade, it's an art: You need to find the right value. Otherwise there would be computers filling premade DCFs with market statistics.
Go to http://pages.stern.nyu.edu/~adamodar/
and search his 2/2/09 entry for this. He explains why analysts should be consistent with the rfr and the risk premium.
You should never use the historical yield on a 10 year treasury. That's just ridiculous. The current market conditions aren't reflective of the "historical average."
The risk free rate you use should have the same time to maturity as the investment. If you're looking at a 10 year time frame for the investment then use the 10 year rate. If you looking at a one or five year project use a one or five year rate...
Damodaran site is the shit. Got me through all 4 years of college.
In a one-hour seminar I learned more from that guy than quite a bit of time in my finance classes.
Correct me if I'm wrong, but in a market like this, I thought it is recommended to use the historical treasury yield both for the risk-free rate and the risk-premium calculation. The motivation being that you expect market conditions to return to their historical average over the long run.
You are an idiot. The current interest rate prices everything the market expects to happen in the future into the rate. That includes the fact that people may expect things to return to normal. Using an average historical interest rate is retarded. I hope you're an Ivy League English major.
I would argue that for the MRP you would certainly want to use historical returns for 10-year note, otherwise you are measuring completely the wrong thing. It doesn't make any more sense to use the current RFR in MRP than it does to use yesterday's change in S&P 500 as the historical return.
In my opinion, its all relative to the time period.
Also, to the point about whether to use the current rate or what... I do not entirely agree with the whole "Market Efficiently prices in [fill in blank]" but thats a whole other debate that is very well publicized. With the volatility in this market, I don't know if you could say that's completely true. Anyway... I would use LIBOR as the basis anyway, its closer to the practical risk-free in many ways.
BTW, pretty sure he didn't mean like average historical as like 10 years but maybe the past year or month or less. I mean if you were to use the rates for the day the Fed released its long-term treasury buy back program, the week before and the week after you'd have quite different results. It's an interesting point worth considering at least, I wouldn't say that considering some sort of average is completely nonsense, even though I understand your point about expected value well. It's not black and white, as someone mentioned before, its more art than science.
No Leverage, before you call me an idiot, the issue certainly isn't as black and white as you suggest.
What you are proposing is to use the implied ERP, which essentially compares historical stock market performance to the current treasury yield. In that case, yes, it would also make sense to use the current treasury yield for the risk-free rate.
But in reality, many people - including many of my professors - are still using the historical ERP, which compares historical stock market performance to the historical average treasury yield. In this case then, it would also make sense to use the historical treasury yield for the risk-free rate.
I don't know why both methods are still in use, but the fact is they are. The important thing, as MonkeyKingdom mentioned, is to stay consistent between the risk-free rate and the risk premium (ie. use current t-bond yield for both or historical t-bond yield for both). Otherwise, you run into trouble in markets like today: if you use a historical ERP and a current risk-free rate, you will arrive at a much lower cost of capital - one that is probably unrealistic if you're trying to value a company 10, 15, 20 years into the future.
As previously mentioned, this stuff is more of an art than a science.
Market Risk Premium and Beta change from country to country (Originally Posted: 11/23/2015)
Hi friends, I have the following 3 questions:
1.Market Risk Premium: Does risk premium change from country to country? What is the current risk premium used in London?
My guess would be that after the crisis given the expansionary monetary policy, the yields on bonds decreased, thus Rf is lower and the returns on the stock market increased given that increase on investment in the industry. Thus, the spread between the Stocks and bonds is higher. However, I also need to consider that Market risk premium is a historical average. so the question would be how would the current economic conditions impact the risk premium if its a historical average.
Thank you so much
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