Equity Risk Premium for India
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http://www.Indianequities.in Hi & Welcome back to http://www.Indianequities.in, In this post I am going to cover Equity risk premium calculation for India? Why it is needed? How it can be helpful for calculating Hurdle rates? So, we will start with, why equity risk premium is needed? As investors we have an option of investing in risk free assets in which there is a minimum guaranteed interest rate which is been promised by the Indian government to pay back in the given time horizon. Instead of investing in such a deal we are investing in a business as an outsider with lot of uncertainties. In this context investors look for an extra premium for the risk he has taken by investing in this business. This is termed as Equity risk premium. So far, so good. But how about calculating equity risk premium. For calculating equity risk premium Aswat Damodaran() has spoken about three ways of doing it. Ie., 1. Survey premiums: This is done by enquiring various CFO’s or Individual Investor or Institutional Investors about their estimate of equity of risk premium and coming to an consensus. As these estimates are made of recent market movement these cannot be taken in to consideration for long term estimates so survey premiums cannot be used for finding equity risk premium. 2. Historic risk premium: This is done by considering historic data of market. But there is an internal flaw in this mechanism as there is no hard and fast rule for time horizon. As we use more time data we achieve a low equity risk premium which can be even less than risk free rate and emerging countries with less data will may get a risk premium which may not be in line with risk premium that the country actually has. So the solution to this problem is by calculating equity risk premium of mature market and adding country premium. This is called as the modified historic risk premium. But how to find out country has the mature market? For this question we should rely on our Big Brother (USA)as it is have market data from 1928 and for calculating countries premium we will go with Default spread + Relative standard deviation method in which the default spread of the country is scaled with the standard deviation of the equity to that of
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Equity risk premium calculation for India and rest of the world using Default spread + Relative standard deviation along with survery premium method and Historical data methods.
Transcript of Equity Risk Premium for India
http://www.Indianequities.in Hi & Welcome back to http://www.Indianequities.in, In this post I am going to cover Equity risk premium calculation for India? Why it is needed? How it can be helpful for calculating Hurdle rates? So, we will start with, why equity risk premium is needed? As investors we have anoptionofinvestinginriskfreeassetsinwhichthereisaminimumguaranteedinterestrate which is been promised by the Indian government to pay back in the given time horizon. Instead of investing in such a deal we are investing in a business as an outsider with lot of uncertainties. In this context investors look for an extra premium for the risk he has taken by investing in this business. This is termed as Equity risk premium. Sofar,sogood.Buthowaboutcalculatingequityriskpremium.Forcalculating equity risk premium Aswat Damodaran() has spoken about three ways of doing it. Ie.,1.Surveypremiums:ThisisdonebyenquiringvariousCFOsorIndividualInvestoror InstitutionalInvestorsabouttheirestimateofequityofriskpremiumandcomingtoan consensus. As these estimates are made of recent market movement these cannot be taken in to consideration for long term estimates so survey premiums cannot be used for finding equity risk premium. 2.Historic risk premium: This is done by considering historic data of market. But there is aninternalflaw in this mechanismas there is no hardand fast rule for time horizon. As we use more time data we achieve a low equity risk premium which can be even less than riskfreerateandemergingcountrieswithlessdatawillmaygetariskpremiumwhich may not be in line with risk premium that the country actually has. So the solution to this problemisbycalculatingequityriskpremiumofmaturemarketandaddingcountry premium.Thisiscalledasthemodifiedhistoricriskpremium.Buthowtofindout countryhasthematuremarket?ForthisquestionweshouldrelyonourBigBrother (USA)as it is have market data from 1928 and for calculating countries premium we will gowithDefaultspread+Relativestandarddeviationmethodinwhichthedefault spreadofthecountryisscaledwiththestandarddeviationoftheequitytothatof http://www.Indianequities.in standarddeviationofthebondmarket.Bycalculatingusingtheabovesaidmethodwe will arrive equity risk premium for india. Calculation of equity risk premium of India in August of 2015 Equity risk premium of Mature Market(USA) is : 4.20% Country default spread for india is : 2.0% Percentage change of standard deviation of equities over previous year 47.87% Percentage change of standard deviation of bonds over previous year 16.51% Country Premium = (Country default spread)*[cEquiticscBcnd mcrkct = 2.0 * [47.8716.51 = 5.79% Equity risk premium (ERP) = ERP of mature market+ country premium = 4.20+5.79 = 9.99 So by investing in Indian equity we expect a risk premium of 9.99%(Note: This large number of ERP is because of volatility in equity market if the market is stable and certain we would have gotten a lesser number as the risk is less. More over the information providedisbasedonmyassumptionitshouldnotbetakenasabasisforyourinvestment decisions.) http://www.Indianequities.in Data for calculating Standard Deviations Equity Market BSE 500 from 01/Aug/2013 to 07/Aug/2015 Bond Market from 01/Aug/2013 to 07/Aug/2015 http://www.Indianequities.in Standard deviation of Bonds & BSE 500 Regards Ravi Teja http://www.indianequities.in
