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Aug. 15, 2007 The volatility in the debt and equity markets lately has many in the financial worlds reassessing risk and their relation to it. Risk, which has been largely ignored in the past few years, is now under the spotlight. That makes a recent presentation on risk and its relation to value all the more interesting. Aswath Damodaran, Professor of Finance at Stern School of Business, New York University, recently took a look at the Equity Risk Premium in a presentation at Wichita. Why is this of interest to investors and financial managers? The equity risk premium measures what investors demand over and above the risk-free rate for investing in equities as a class. Damodaran shows that the equity risk premium has probably been view as being higher than it really is. What’s the big deal with that? The big deal is that if the equity risk premium is perceived to be higher than it really is, the values obtained from the use of the inflated equity risk premium will be too low. The current t risk premium used by many financial practitioners runs in the upper 6 to 7 percent range. However, Damodaran’s review of the rate found in the implied premium turns up a much lower number – something closer to 4 percent. He argues that “if you use too high a risk premium, you will end up with too low a value.” The cost to this error is underinvestment. IF Damordaran is on target, many companies are internally valuing themselves and their projects at too low of a value, and under-investing. The upsides is that many companies may in fact be more valuable than they think they are. Damodaran’s analysis can be seen at his site - http://pages.stern.nyu.edu/~adamodar/New_Home_Page/country.htm ------------ About the author: Dwayne Hines writes on both fitness and finance, and currently has 12 books selling in major bookstores. He also writes for major magazines such as OnFitness and Ironman. Email: dhines@cpu-net.net Comment on this article here! ------------ All articles are EXCLUSIVE to Useless-Knowledge.com. Please link to this article rather than copying and pasting it onto your site (which would be unauthorized and illegal). |
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