The equity risk premium is the difference between the yields on stocks and risk free assets. It is a component in the evaluation of companies. This article reviews the historical real (inflation adjusted) yields on stocks and Government bonds is Israel in the years 1980-2018.<\/p>\n\n\n\n
The findings are that the geometrical mean real yields were 5.1% on stocks and 2.3% on bonds, resulting in a 2.8% equity premium.<\/p>\n\n\n\n
In the late 1970s and early 1980s the prices of banking stocks were manipulated and did not represent market forces. When the banking stocks were deducted, the stocks’ yield declined to 4.0% and the equity premium to 1.7%.<\/p>\n\n\n\n
Since finance literature also supports the calculation of the equity premium through arithmetical means, those were calculated too. the results changed to: stocks \u2013 10.4%, bonds \u2013 2.5% and the premium \u2013 7.8%, 5.0% higher that the geometrical mean premium.<\/p>\n\n\n\n
After the deduction of banking stocks, the results are: stocks \u2013 11.5%, bonds \u2013 2.5% and the premium \u2013 9.0%, 7.3% higher that the geometrical premium.
The deduction of banking stocks reduced the cumulative stock yield by 221%, but the arithmetical mean is higher, because the variance was higher. Therefore, a higher premium is required to compensate for the increased risk.<\/p>\n\n\n\n
The arithmetical mean is also affected by the frequency of measurement \u2013 monthly, quarterly, annual etc. The findings were that the premiums increased as the measuring period lengthened. The timing of the measuring period has a profound effect. Therefore 10 and 20 year moving averages are displayed.<\/p>\n\n\n\n