Determinants of the implied equity risk premium in Brazil

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Antonio Zoratto Sanvicente
Mauricio Rocha Carvalho


This paper proposes and tests market determinants of the equity risk premium (ERP) in Brazil. We use implied ERP, based on the Elton (1999) critique. We demonstrate that the calculation of implied, as opposed to historical ERP makes sense, because it varies, in the expected direction, with changes in fundamental market indicators. The ERP for Brazil is calculated as a mean of large samples of individual stock prices in each month in the January, 1995 to September, 2015 period, using the “implied risk premium” approach. As determinants of changes in the ERP we obtain, as significant, and in the expected direction: changes in CDI rate, country debt risk spread, US market liquidity premium and level of the S&P500. The influence of the proposed determining factors is tested with the use of time series regression analysis. The possibility of a change in that relationship with the 2008 crisis was also tested, and the results indicate that the global financial crisis had no significant impact on the nature of the relationship between the ERP and its determining factors. For comparison purposes, we also consider the same variables as determinants of the ERP calculated with average historical returns, as is common in professional practice. First, the constructed series does not exhibit any relationship to known market events. Second, the variables found to be significantly associated with historical ERP do not exhibit any intuitive relationship with compensation for market risk.

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