Equity Risk Premium (ERP) Model

    Latest Update: February 11, 2019
    Updated by: John Moschella, CFA, CPA 
    Model Summary: This model uses the Fed Funds rate, 10-year U.S. Treasury rate, implied volatility, equity market returns, and the Constant Sharpe Approach, to estimate the Equity Risk Premium (ERP). The ERP and the Capital Asset Pricing Model (CAPM) are used together to calculate the required return on equity for our DCF-based share valuation models.​
    What changed in the latest version: The model has been updated to include the latest data through February 11, 2019, as well as the FOMC Statement and Projection Material from the December 19, 2018 Fed meeting, and the Statement from the January meeting. This reflects a 25 basis point increase in the target Fed Funds rate to a range of 2.25% to 2.50%, from  the prior range of 2.00% to 2.25%. In addition, the Fed's median projection has decreased from 3.1% to 2.9% for 2019, and from 3.4% to 3.1% for 2020. As a result, we have updated the ERP model to include just two 25 basis point increases in 2019, which we have include in the second and fourth quarters. This assumes the Fed takes a pause for the January 30, 2019 and March 20, 2019 meetings. We have included one 25 basis point increase in the second quarter of 2020.
    We have also performed data maintenance to include the latest available equity returns, volatility, and spread between the 10-year U.S. Treasury security and the Fed Funds rate. In our spread forecast we move from ~0.6% spread to ~1.0% by the end of 2020, which includes some effect from the balance sheet normalization program.
    Latest ERP Estimate for 4Q2018: 5.5% versus the previous estimate of 5.2%. The slight increase from the last update reflects the impact of lower interest rates (spread) offset by increased volatility and lower equity market return projections. The ERP remains below the historic average of 6.0%.
    Disagree with this projection? We maintain "base-case" models for our community members to download and input their own forecast. There are many factors you can change in the ERP model including: the timing of Fed rate changes, the spread in the 10-year Treasury vs the Fed Funds rate, volatility assumptions, and equity market return projections. Try it today, and share your forecast with the Gutenberg Community. 
ERP Model.xlsx
File Size: 2039 kb
File Type: xlsx
Download File
Planned ERP Model updates:​
  • March 20, 2019: FOMC meeting.   Target Fed Funds rate update. 
  • April 1, 2019: Quarterly data Maintenance (update equity returns, volatility, and interest rates).
  • April 30, 2019: FOMC meeting.Target Fed Funds rate update. 
  • June 18, 2019: FOMC meeting.Target Fed Funds rate update.
  • July 30, 2019: FOMC meeting.Target Fed Funds rate update.
  • September 17, 2019: FOMC meeting.Target Fed Funds rate update.

Models From Our Community

Last Updated: February 22, 2017
2017 ERP Estimate: 5.0%
​Model Up Votes-to-Total Votes: 70%
Summary of Model Estimates: In general I have a bullish outlook on the market for 2017 based on the following:
  • Trump's expected business deregulation initiatives and corporate tax reform (including the repatriation tax) could begin soon and may drive an increase in reinvestment in the US Economy. In the long-term, I believe Trump's economic policies will eventually bring some form of financial crisis (possibly with the overvalued stock market as the underlying asset bubble) but as for 2017, I think the market will continue to propel to higher levels. To reflect this view I have incorporated a total return of 18% on the S&P500 into my ERP model. 
  • I believe the positive market conditions will cause interest rates to increase above 3% by the end of the year.
  • The VIX has been fluctuating on the low side this year (between 10-12%) despite some of the President's volatile decisions. I believe volatility will increase later in the year and reach a 12-month trailing average of 15.5%.
  • Based on these assumptions I expect the market's Equity Risk Premium to reach 5% by the end of 2017.
Paul DeAngelis ERP Model.xlsx
File Size: 1066 kb
File Type: xlsx
Download File

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