Risk in Equity Premium- An Indian Context

ABSTRACT

We estimate the equity risk premium in India using data for the last 25 years. We address the shortcomings of existing indices by constructing our total own return index for the 1080 and early 1990s. We use our estimates of the extent of financial repression during this period to construct a series of the risk free rate in India going back to the early 1980s. We find that the equity-risk premium is about 8 3/4% on a geometric mean basis and about 12 1/2% on an arithmatic mean basis. There is no significant difference between the pre reform and post reform period: the premium has declined marginally on a geometric mean basis and has risen slightly on an arithmetic mean basis. The reason for this divergence between the sub-period behaviors of the two means is the increase in the annualized standard deviation of stock market returns from less than 20% in the pre reform period to about 25% in the post reform period. The higher standard deviation depresses the geometric mean in the post reform period.

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