Estimation of Equity Risk Premiums (ERP) in an Emerging Stock Market: The Nigerian Case

Abstract

Obviously the equity risk premium (ERP) is an important parameter in finance, more especially in fixing the cost of equity capital and giving values to assets. However, its estimation has challenged academics, analysts and other practitioners in the field of finance as to which of the estimation approaches presents the best result for practical application. It was also observed that most of the studies on this important aspect of finance have been mostly conducted in the developed stock markets with very little or none done on some of the emerging markets. With this in mind, the researcher was moved to place an emerging stock market on the map of researches on the ERP. At the end of the study it was discovered that as it is in the literature, arithmetic average yields higher risk premiums than the geometric average as can be seen in tables 4.5 and 4.6. For the period 2000-2011, an arithmetic average risk premium, for stocks over T-bills of 1.41% and a geometric average risk premium of -5.01% were reported. Based on the computations and analysis carried out in this study, it is hereby recommended that the Cumulative Arithmetic Mean type of averaging the returns should be engaged in the determination of market risk premium, especially in the emerging stock markets as it yields the best result.