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- W105883817 abstract "The equity risk premium is an important component in the valuation process. Prior studies that have reverse-engineered valuation models to estimate the equity risk premium suffer from some methodological flaws. In particular, they do not account for a competitive advantage period and the value of real options available to firms. These flaws constrain the equity risk premium imputed from valuation models to very low values. This paper constructs a residual income valuation model that incorporates the economically appealing concepts of competitive advantage and option value. An estimate of the equity risk premium is then reverse-engineered from this model using a simulation technique. Two important inferences are made by this paper. First, even without consideration for option value, the equity risk premium implied by market prices is 5 to 6% in the U.S. and 6 to 7% in Australia. Thus, even if real option value is assumed to equal zero, an appropriate estimate of equity risk premium for investment decision-making is 6%. Second, by recognising real option value, the equity risk premium implied by market prices is 6 to 7% in the U.S. These estimates are consistent with realised risk premiums and are higher than those reported in the prior literature." @default.
- W105883817 created "2016-06-24" @default.
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- W105883817 date "2006-01-01" @default.
- W105883817 modified "2023-09-27" @default.
- W105883817 title "Reverse-engineering the equity risk premium embedded in market prices" @default.
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