How is equity risk premia calculated?

Answer

There are three steps to calculating equity risk premia. 

Step 1: Get the risk premia 𝛾_𝑗,𝑡 from market prices:

Step 2: Estimate the price 𝜆_𝑘,,𝑡 of each risk factor given the factor exposures 𝛽_{𝑗,𝑘,𝑡} of each transaction. 

Step 3: Apply factor prices (lambdas) to new assets to compute their risk premia given their factor exposures. 

 

Further Reading

A comprehensive explanation of our Equity Risk Premia approach can be found here.