copyright 2001. john r. graham and campbell r. harvey. 1 expectations of equity risk premia,...
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![Page 1: Copyright 2001. John R. Graham and Campbell R. Harvey. 1 Expectations of Equity Risk Premia, Volatility, and Asymmetry: From a Corporate Finance Perspective](https://reader035.vdocuments.site/reader035/viewer/2022062517/56649f225503460f94c3aae9/html5/thumbnails/1.jpg)
Copyright 2001. John R. Graham and Campbell R. Harvey.
1
Expectations of Expectations of Equity Risk Premia, Volatility, and Asymmetry: Equity Risk Premia, Volatility, and Asymmetry:
From a Corporate Finance PerspectiveFrom a Corporate Finance Perspective
John R. GrahamDuke University, Durham, NC USA
Campbell R. HarveyDuke University, Durham, NC USA
National Bureau of Economic Research, Cambridge, MA USA http://www.duke.edu/~charvey
AIMR Equity Risk Premium ForumNew York, NY
November 8, 2001
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Copyright 2001. John R. Graham and Campbell R. Harvey.
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Graham/Harvey: Expectations of Risk Premia
Measuring CFO Market Expectations
• Survey CFOs every quarter• Q2 2000 through Q3 2001 (six quarters)
• ~200 responses per quarter (1,200 total obs.)
• Why CFOs? – We know they use CAPM from previous surveys– Hence, they have thought hard about risk premium– Should not be biased the way that analyst forecasts
might be
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Copyright 2001. John R. Graham and Campbell R. Harvey.
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Graham/Harvey: Expectations of Risk Premia
Across Time and Different Horizons
• 10-year risk premium around 4% and stable whereas 1-year risk premium quite variable
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6-Jun-00 7-Sep-00 4-Dec-00 12-Mar-01 7-Jun-01 10-Sep-01
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6-Jun-00 7-Sep-00 4-Dec-00 12-Mar-01 7-Jun-01 10-Sep-01
10-year premium 1-year premium
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Copyright 2001. John R. Graham and Campbell R. Harvey.
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Graham/Harvey: Expectations of Risk Premia Past Returns Impact Expected Premia
• 1-year risk premium sensitive to past returns
y = 0.1096x + 2.3068
R2 = 0.7141
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-20 -15 -10 -5 0 5 10
Past quarters' return
One
-yea
r pr
emiu
m
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Copyright 2001. John R. Graham and Campbell R. Harvey.
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Graham/Harvey: Expectations of Risk Premia Past Returns Impact Expected Premia
• 10-year risk premium not sensitive
y = 0.0179x + 4.3469
R2 = 0.1529
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Past quarters' return
One
-yea
r pr
emiu
m
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Copyright 2001. John R. Graham and Campbell R. Harvey.
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Graham/Harvey: Expectations of Risk Premia
Measuring Volatility
• Able to deduce each respondent’s probability distribution– “High range: During the next year, there is a 1-in-10
chance the S&P 500 return will be higher than _____%”
– “Low range: During the next year, there is a 1-in-10 chance the S&P 500 return will be lower than ______%”
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Copyright 2001. John R. Graham and Campbell R. Harvey.
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Graham/Harvey: Expectations of Risk Premia
Measuring Volatility
• Market volatility is
average of individual volatilities (average volatility)
+ dispersion of risk premium forecasts (disagreement)
• We consider both components
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Copyright 2001. John R. Graham and Campbell R. Harvey.
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Graham/Harvey: Expectations of Risk Premia Past Returns Impact Expected Volatility
• Average volatility (1-year) weakly related to past returns
y = -0.0452x + 6.4722
R2 = 0.1282
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-20 -15 -10 -5 0 5 10
Past quarter's return
Ave
rage
vol
atil
ity
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Copyright 2001. John R. Graham and Campbell R. Harvey.
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Graham/Harvey: Expectations of Risk Premia Past Returns Impact Expected Volatility
• Disagreement (1-year) strongly related to past returns
y = -0.153x + 4.3658
R2 = 0.7298
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-20 -15 -10 -5 0 5 10
Past quarter's return
Dis
agre
emen
t vo
lati
lity
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Copyright 2001. John R. Graham and Campbell R. Harvey.
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Graham/Harvey: Expectations of Risk Premia Past Returns Impact Expected Skewness
• Average skewness (1-year) strongly related to past returns
y = 0.1438x - 0.8105
R2 = 0.7636
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-4
-3
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-1
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Past quarter's return
Ave
rage
asy
mm
etry
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Copyright 2001. John R. Graham and Campbell R. Harvey.
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Graham/Harvey: Expectations of Risk Premia Expected Premia and Expected Volatility
• Average volatility (1-year) negatively related to expected returns
y = -0.5178x + 5.2945
R2 = 0.2538
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2 3 4 5 6 7 8
Average volatility
Exp
ecte
d pr
emia
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Copyright 2001. John R. Graham and Campbell R. Harvey.
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Graham/Harvey: Expectations of Risk Premia Expected Premia and Expected Volatility
• Disagreement volatility (1-year) strongly negatively related to expected returns
y = -0.6977x + 5.341
R2 = 0.9283
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2 3 4 5 6 7 8
Disagreement volatility
Exp
ecte
d pr
emia
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Copyright 2001. John R. Graham and Campbell R. Harvey.
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Graham/Harvey: Expectations of Risk Premia Expected Premia and Expected Volatility
• Disagreement volatility (10-year) strongly positively related to expected returns
y = 0.9949x + 1.4616
R2 = 0.6679
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1
2
3
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5
2 3 4 5 6 7 8
Disagreement volatility
Exp
ecte
d pr
emia
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Copyright 2001. John R. Graham and Campbell R. Harvey.
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Graham/Harvey: Expectations of Risk Premia
Impact of September 11, 2001
Pre-Sept. 11 Post-Sept. 111-year premium
Mean premium 0.05 -0.70Average volatility 6.79 9.76Disagreement volatility 6.61 7.86
10-year premium
Mean premium 3.63 4.82Disagreement volatility 2.36 3.03Observations 127 33
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Copyright 2001. John R. Graham and Campbell R. Harvey.
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Graham/Harvey: Expectations of Risk Premia
What have we learned?
• Forecasts impacted by past returns (expectational momentum)
• Leverage effect validated with new expectational data
• Individual volatilities seem low
• Positive relation between risk and expected return - only at longer horizons
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Copyright 2001. John R. Graham and Campbell R. Harvey.
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Graham/Harvey: Expectations of Risk Premia
Outstanding issues
• 1-year forecasts unlikely used as the “hurdle rate” for 1-year project evaluation
• Difference between what CFOs think will happen to the market and their internal hurdle rates
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Copyright 2001. John R. Graham and Campbell R. Harvey.
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Graham/Harvey: Expectations of Risk Premia
Outstanding issues
• Hurdle rates and risk premium:– Premium should be high given that we are in
recession– Higher hurdle rates are often used which proxy for
• Scarcity of management time
• Financial flexibility options
• Option to wait
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Copyright 2001. John R. Graham and Campbell R. Harvey.
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Graham/Harvey: Expectations of Risk Premia
Next phase
• Individual CFO interviews:– 25 interview scheduled for first week in December– Will ask them to explain the difference between
their market forecast and their internal hurdle rates
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Copyright 2001. John R. Graham and Campbell R. Harvey.
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Graham/Harvey: Expectations of Risk Premia
Appendix
• Market volatility
Var[r]= E[Var(r|Z)] + Var(E[r|Z)]
average vol. disagreement vol.
• Individual volatilities (Davidson and Cooper)
Variance = ([r(0.90) - r(0.10)]/2.65)2
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Copyright 2001. John R. Graham and Campbell R. Harvey.
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Graham/Harvey: Expectations of Risk Premia
Appendix
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Proportion
1-year premiumSeptember 10, 2001
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Copyright 2001. John R. Graham and Campbell R. Harvey.
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Graham/Harvey: Expectations of Risk Premia
Appendix
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< -20
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Proportion
10-year premiumSeptember 10, 2001
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Copyright 2001. John R. Graham and Campbell R. Harvey.
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Graham/Harvey: Expectations of Risk Premia
Appendix
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<3 6 9 12 15 18 20 >20
Proportion
1-year individual volatilitiesSeptember 10, 2001
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Copyright 2001. John R. Graham and Campbell R. Harvey.
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Graham/Harvey: Expectations of Risk Premia
Appendix
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Proportion
1-year individual skewnessSeptember 10, 2001