Key Points:
- Calling the equity risk premium a fear premium can change our perspective on so-called anomalies in the market.
- Risk is not the only factor contributing to the equity risk premium, and other factors such as fear and market inefficiency may play a role.
- The equity risk premium is observed to be large, but the question remains as to how much of it is a genuine risk premium and how much is due to other factors.
- Factors such as value, size, momentum, and accruals may contribute to premiums, but they are not necessarily risk premiums.
In a recent forum on equity risk premium, participants including Rob Arnott, Laurence B. Siegel, Cliff Asness, Elroy Dimson, Roger G. Ibbotson, Martin Leibowitz, Rajnish Mehra, and Jeremy Siegel examined the nature of the concept. Arnott suggested that instead of calling it a risk premium, it could be seen as a fear premium, which would give a different perspective on anomalies in the market. For example, buying loathed and feared companies would be expected because it is a scary investment. The size effect would also be expected but relatively weak because buying small, less understood companies generates more fear. The discussion also touched on factors such as liquidity and long-horizon mean reversion, which could contribute to the equity risk premium. However, the question remains as to how much of the premium is a genuine risk premium and how much is due to other factors. Factors like value, size, momentum, and accruals may contribute to premiums, but they are not necessarily risk premiums. Overall, the forum highlighted the complexities of the equity risk premium and the need to consider various factors when examining it.
