I-ADVISE Study on Implicit Market Risk Premium

Investors are comfortable with lower market risk premium
Study: Rising enterprise values are caused by declining excess return of shares as compared to securities

Since the last six month of 2012 to first quarter 2014 investors anticipate virtually a continuous decreasing market risk premium for investing in DAX-listed companies. At the end of second quarter 2014 it totals 5.9 % (weighted average) and is therefore 70 basis points below average during the period 2008 to 2013/14. This is the finding of an I-ADVISE research study which determines the implicit market risk premium for selected European and US-markets. The research supports the assumption that the present valuation level at the share market is not only due to low interest rates but also reflects a declining market risk premium requested by market participants.

The market risk premium is the anticipated excess return requested from investors for investing in shares as compared to risk-free securities. Therefore it is a material parameter in each business valuation and investment decision. The lower the market risk premium the higher is the enterprise value based upon profit expectations.

Through its broad-based study I-ADVISE has determined the implicit market risk premium at quarter-end for all DAX, French CAC40, EuroSTOXX and Dow Jones Index-listed shares. The implicit market risk premiums are recalculated out of market capitalization, earnings forecasts by analysts, current base rates and the specific risk which is factored through the beta factor concept for each share at each quarter-end by using an income approach model. The results are condensed in a market risk premium for the market as a whole.

For DAX-listed companies the implicit I-ADVISE market risk premium totals 6.6 % (weighted average, pre-tax) during the period March 2008 to June 2014. These are 100 base points below EuroSTOXX 50-listed companies.

To a large extent the market risk premiums showed a parallel trend between the markets concerned. Nevertheless mean values swung in an extensive way – between 3.9 and 9.4 percentage points for DAX 30 companies.

For European markets the implicit market risk premium is presently around 100 base points below average since first quarter 2008, but rebounds at last.

“Any temporary changes of market risk premiums may be relevant within stock trading even if such are caused by exaggerations in the one or the other direction. But market risk premiums for just a single point in time should not be over-interpreted as a distortion may result out of delays in adjusted earnings forecasts and special items. For long-term investment an appropriate average return on the acquisition should be achieved over several years. As a result the investor should consider a long-term average market risk premium” clarifies Dr. Jochen Beumer, I-ADVISE AG.

As yet the study is only available in German. You can download the study here.