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Assessing the equity risk premium (ERP) is an ongoing debate among academics.
Norges Bank Investment Management (NBIM) published a discussion note* on the ERP, in response to the question of whether the Norwegian Sovereign Wealth Fund should further increase its allocation to equities from its current 60 percent. This elaborate overview article describes various explanations put forward by researchers to explain the observed magnitude of the world ERP and its dynamic behavior over time.
They estimate the future world ERP based on historical averages, fundamentals, predictive and cross-sectional regressions, and dividend discount models. Although these models produce different estimates, they generally suggest the long-term world ERP will be between 3 and 4% per annum going forward. For the next five years, Robeco is a bit more optimistic, with an expected ERP of 5.75%, as described in our “Expected Returns 2017-2021” paper.
* “The equity risk premium”, NBIM Discussion note, October 2016.