Question

When you use CAPM to estimate the cost of equity, which one of the following is...

When you use CAPM to estimate the cost of equity, which one of the following is the most appropriate to be used as an estimate of market risk premium?

a. The average market risk premium from 1920 to 2016

b. the average market risk premium from 2010 to 2016

c. the average market risk premium fron Jan 2017 to now

d. The current market risk premium

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Answer #1

c. the average market risk premium from Jan 2017 to now.

We use market risk premium to know how much profitable is the investment as compared to risk free assets like T-bills, but when we use historical data till 2016, the market has been something different at that time and does not account for current investment. So, we will discard option a and b. In option d, the current market risk premium, which accounts for only current extra return on investment as compared to risk free asset, which is not wise option to take as it does not account for recent trends, it does not show any market fluctuation.

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