Perspectives on the equity risk premium

The equity risk premium has commanded the attention of professional economists and investment practitioners for decades. It is critical in financial economics; it determines asset allocations, projections of retirement and endowment wealth, and the cost of capital. Economists are still searching for a simple model that justifies the premium in face of the much lower volatility of aggregate economic data. Although the future equity risk premium is apt to be lower than it has been historically, U.S. equity returns of 2-3 percent over bonds will stilt amply reward those who will tolerate the short-term risk of stocks.