The death of the risk premium -: Consequences of the 1990s.

The authors contend that most of the institutional investing community is expecting far higher returns than are realistic fi-om current market levels. Extrapolating the past is the easiest, and worst, way to forecast the future. Unfortunately, most investors' return expectations are shaped by a simple extrapolation of either recent or longterm past returns. If, instead, the constituent parts of equity market returns an examined, we find that it is remarkably difficult to make a case for a positive equity risk premium (the premium of future stock market returns relative to bond yields) from current market levels. None of this analysis is contingent on any assumption that market P/E ratios or dividend yields should return to historical levels. If market levels are fair and are fully sustained in the years ahead, there is still little or no room for a positive equity risk premium. If there is not a positive risk premium, then actuarial return assumptions are likely to be too optimistic, with far-reaching implications for pension funding ratios, corporate earnings, future pension contributions, and appropriate asset allocation policy.