Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

A First Cut Estimate of the Equity Risk Premium in India

Prof S K Barua and I wrote a paper
estimating the equity risk premium in India using data for the last 25
years. We address the shortcomings of existing indices by constructing
our own total return index for the 1980s and early 1990s. We use our
estimates of the extent of financial repression during this period to
construct a series of the risk free rate in India going back to the
early 1980s. We find that the equity risk premium is about 8.75% on a
geometric mean basis and about 12.50% on an arithmetic mean
basis. There is no significant difference between the pre reform and
post reform period: the premium has declined marginally on a geometric
mean basis and has risen slightly on an arithmetic mean basis. The
reason for this divergence between the sub period behaviour of the two
means is the increase in the annualized standard deviation of stock
market returns from less than 20% in the pre reform period to about
25% in the post reform period. The higher standard deviation
depresses the geometric mean in the post reform period.

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