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1、THEJOURNALOFFINANCE·VOL.LVII,NO.2·APRIL2002TheEquityPremiumEUGENEF.FAMAandKENNETHR.FRENCH*ABSTRACTWeestimatetheequitypremiumusingdividendandearningsgrowthratestomeasuretheexpectedrateofcapitalgain.Ourestimatesfor1951to2000,2.55percentand4.32percent,aremuchlowerthantheequitypre
2、miumproducedbytheaveragestockreturn,7.43percent.Ourevidencesuggeststhatthehighaver-agereturnfor1951to2000isduetoadeclineindiscountratesthatproducesalargeunexpectedcapitalgain.Ourmainconclusionisthattheaveragestockre-turnofthelasthalf-centuryisalothigherthanexpected.THEEQUITYPR
3、EMIUMÐthedifferencebetweentheexpectedreturnonthemar-ketportfolioofcommonstocksandtherisk-freeinterestrateÐisimportantinportfolioallocationdecisions,estimatesofthecostofcapital,thedebateabouttheadvantagesofinvestingSocialSecurityfundsinstocks,andmanyotherapplications.Theaverage
4、returnonabroadportfolioofstocksistyp-icallyusedtoestimatetheexpectedmarketreturn.Theaveragerealreturnfor1872to2000ontheS&Pindex~acommonproxyforthemarketportfolio,alsousedhere!is8.81percentperyear.Theaveragerealreturnonsix-monthcommercialpaper~aproxyfortherisk-freeinterestrate!
5、is3.24per-cent.Thislargespread~5.57percent!betweentheaveragestockreturnandtheinterestrateisthesourceoftheso-calledequitypremiumpuzzle:Stockreturnsseemtoohighgiventheobservedvolatilityofconsumption~MehraandPrescott~1985!!.Weusefundamentals~dividendsandearnings!toestimatetheexpe
6、ctedstockreturn.Alongwithotherevidence,theexpectedreturnestimatesfromfundamentalshelpusjudgewhethertherealizedaveragereturnishighorlowrelativetotheexpectedvalue.Thelogicofourapproachisstraightforward.Theaveragestockreturnistheaveragedividendyieldplustheaveragerateofcapitalgain
7、:A~Rt!5A~Dt0Pt21!1A~GPt!,~1!*FamaisfromtheUniversityofChicagoandFrenchisfromDartmouthCollege.Thecom-mentsofJohnCampbell,JohnCochrane,KentDaniel,JohnHeaton,JayRitter,AndreiShleifer,RexSinquefield,TuomoVuolteenaho,PaulZarowin,andseminarparticipantsatBostonCol-lege,DartmouthColle
8、ge,theNBER,PurdueUniversity,theUniversityofChicago,andWash-in
