http://www.geocities.com/trysail1952/Delta-RiskPremium.htm ______________________________________________ More charts for those with a quantitative bent. It appears to me that ye olde market is already discounting a 5-5� % 10-year Treasury if 2005 S&P earnings come in at the forecast area of $72. Thirty-nine year growth of operating earnings (i.e., from 1966) to that level would be roughly 6.7%, roughly in line with the S&P. While stocks may not be demonstrably "cheap," one can make the case that they are valued to return 6-8%. ______________________________________________ Home: http://www.geocities.com/trysail1952/index.html
Rather than utilizing one equation, the methodology behind the charts employs a dividend discount model. A perpetual future dividend stream (based on a constant payout ratio at the stated earnings growth rate) is discounted back to present value at various discount rates. The present value is then compared to the current (or projected) earnings to produce the Price Earnings Ratio. As you appreciate, since the current risk-free rate is known, the difference between the discount rate that approximates the current price and the observable risk-free rate lets a card shark know what Mr. Market is using for his risk premium today. The curves give one an idea of how Mr. Market might price things were he to have one of his periodic mood swings.