An Empirical Examination of Ex Ante
Estimates of the Market Risk Premium

Abstract

This research investigates a new method for estimating the price of risk in the market using information on bond yield spreads. An empirical examination of the model indicates the ex-ante risk premium estimates, which vary significantly over time, have an average one-to-one relationship with future market returns. There is strong evidence that the procedure supplies forecasts that can be very useful in predicting future returns on stocks, high-yield bonds, and the overall market. It may therefore also assist in estimating the required return on assets needed to compute the present value of investments.