What’s the outlook for the excess return on US stocks over the “risk free” rate? The answer varies with the forecaster, of course. For some insight into how much the estimates of the equity risk premium vary, two finance professors and an assistant recently polled thousands of professors, economists and assorted analysts and companies via email, receiving 3,768 responses with specific forecasts for 2011. Among the findings, detailed in a new working paper: the average risk premium “used by professors and companies is higher than the one used by analysts.”

The average estimate from the professors anticipates a risk premium of 5.7% for 2011. That compares with a forecast of 5.6% from respondents at “companies” and 5.0% from “analysts,” according to “US Market Risk Premium used in 2011 by Professors, Analysts and Companies: a survey with 5.731 answers,” authored by a pair of professors at the IESE Business School in Madrid.
The estimates from professors and analysts are slightly lower, on average, than their 2010 predictions, as reported in a preceding survey. By contrast, companies overall forecast a slightly higher risk premium for 2011 vs. last year.

Source: “US Market Risk Premium used in 2011 by Professors, Analysts and Companies: a survey with 5.731 answers”
Unsurprisingly, the new survey’s main result is that “there is a lack of consensus among professors, analysts and companies about the magnitude of [the equity risk premium] for USA,” the authors note. A key reason seems to be that the source material for estimating the excess return on stocks draws on a wide spectrum of methodologies. The paper asked about books or articles that are used in support of a given estimate. The answers stack up as follows:

Source: “US Market Risk Premium used in 2011 by Professors, Analysts and Companies: a survey with 5.731 answers”
Is estimating the equity risk premium an art or a science? Actually, it’s both! The trick is figuring out which one dominates, and by how much.
Finally, a bit of historical perspective on what’s actually unfolded in the market. For the decade through the end of 2010, the realized premium on US stocks is an annualized 1.37%, according to Professor Aswath Damodaran at the Stern School of Business at New York University. Ouch! Since 1961, the premium is a more reassuring 5.83%; since 1928, the annualized premium jumps to 7.62% through the end of last year. Anyone want to take a guess as to which slice of history applies from here on out? Or, perhaps you have a completely different forecast? If so, a team of professors in Madrid may be interested.