I reader asked why so many practitioners use high Equity Risk Premiums in their valuations and fairness opinions.
In particular, he mentioned a specific assumption set he had seen including:
- ERP of 6.8%
- company specific risk premium of 4%
He also commented on how haphazard the use of risk premiums can be and referenced a few sources I’ve used myself.
The ERP of 6.8% does seem high. However, it really isn’t possible to comment on the specifics of the company specific risk premium without knowing the company.
Although I haven’t updated my research on this in a few years, in my own work I still generally stick with a range of 3% to 5% for an ERP, before considering company specific factors, liquidity, and so on. Historically / empirically estimated ERPs shouldn’t change frequently since the time series used is long. Another few years on a 20 year estimation period shouldn’t have much impact.
Why some practitioners persist in using too-high ERP estimates
This delves into the area of philosophy, but here are my top reasons (a post from 2011 also covers this):