Thursday, June 29, 2006

Estimation of the equity premium in India

Jayanth Varma and Samir Barua have written a mini-paper on estimation of the historical equity premium in India. They wage a brave war against difficult data problems, and come up with an estimate of 8.75 percent.

A while ago, in October 2005, I had written some notes about my views about the equity premium in India. In that note, I had argued that looking forward, one might estimate an Indian equity premium like 8%. With a short rate of roughly 5% and an equity premium like 8%, this means nominal equity index (total) returns might work out to around 13%.

An equity premium of 800 bps is huge! Just to be safe, in all our discussions about the New Pension System, much more conservative numerical values have been utilised. As an example, in my paper A sustainable and scalable approach in Indian pension reform, which is forthcoming in the LKYSPP India/China book, the three scenarios (page 28) have values of the equity premium of 3.5%, 4% and 4%.

Update: Kaushik Gala says:

Thanks for pointing to the IIM-A equity premium paper. You must be familiar with other estimates as well:
  1. 5.2% by Damodaran,
  2. 11% by Mehra,
  3. 6% by JM Morgan Stanley,
  4. 7% or 4.6%, by Haribhakti.

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