The Risk Premium Factor, + Website: A New Model for Understanding the Volatile Forces that Drive Stock Prices

210 Pages·2011·5.568 MB·English

by  Stephen D. Hassett

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The Risk
Premium
Factor
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The Risk
Premium
Factor
A New Model for Understanding
the Volatile Forces that Drive
Stock Prices
STEPHEN D. HASSETT
John Wiley & Sons, Inc.
iii
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Copyright (cid:2)c 2011 by Stephen D. Hassett. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.
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LibraryofCongressCataloging-in-PublicationData:
Hassett,StephenD.,1961–
Theriskpremiumfactor:anewmodelforunderstandingthevolatileforcesthatdrivestock
prices/StephenD.Hassett.
p.cm.—(Wileyfinanceseries;702)
Includesindex.
ISBN978-1-118-09905-6(cloth);ISBN9781118118597(ebk);
ISBN9781118118603(ebk);ISBN9781118118610(ebk)
1.Stocks–Prices. 2.Corporations–Valuation. 3.Businesscycles. 4.Stockexchanges.
I.Title.
HG4551.H342011
332.63(cid:3)222—dc23
2011017550
PrintedintheUnitedStatesofAmerica
10 9 8 7 6 5 4 3 2 1
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To Anne, Sarah, and Charlotte Hassett
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Contents
ListofFigures xi
ListofTables xiii
Preface xv
EvolutionofaTheory xvi
Overview xvii
HowThisBookIsStructured xxi
AsYouBegin xxii
Acknowledgments xxiii
AbouttheAuthor xxv
CHAPTER1
UnderstandingtheSimplicityofValuation 1
Rates,Compounding,andTimeValue 3
WhyTimeValueMattersfortheStockMarket 3
ValuingaPerpetuity 4
ConstantGrowthEquation:TheKeytoUnderstandingthe
StockMarket 5
NottheFirsttoTryThis 6
WhyGrowthRateandCostofCapitalMatter 9
P/ERatioExpansionandContraction 10
CAPM,RiskPremium,andValuation 11
EquityRiskPremium 11
ImpactofRiskPremiumonValuation 13
ChapterRecap 14
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viii CONTENTS
PARTONE
ExploringtheRiskPremiumFactorValuationModel
CHAPTER2
TheRiskPremiumFactorValuationModel 19
TheRPFModelIsSimple,butDoesItWork? 21
EstimatingtheRPF 24
PotentialCausesforShiftsintheRPF 27
PotentialWeaknessesinRPFTheoryandMethodology 28
AdjustedRisk-FreeRate 29
ComparisontotheFedModel 29
ChapterRecap 31
CHAPTER3
SolvingtheEquityPremiumPuzzle:TheLinktoLossAversion 33
LossAversion 34
LossAversionandCorporateDecisionMaking 34
AttemptstoSolvetheEquityPremiumPuzzle 35
ImpactofInflationonValue 39
BacktoLossAversion 39
OurReptilianBrain 40
ChapterRecap 42
CHAPTER4
TheRPFModelandMajorMarketEventsfrom1981to2009 43
EfficientMarketHypothesis 44
HowtheRPFValuationModelExplainsBlackMonday 45
2000“Dot-com”Bubble:RPFModelSuggestsSignificant
BubblefortheS&P500 47
HowtheRPFValuationModelExplainsthe2008to2009
MeltdownandRecovery 49
MarketsMostlyEfficientandRational,butPronetoMistakes 52
ChapterRecap 53
PARTTWO
ApplyingtheRiskPremiumFactorValuationModel
CHAPTER5
ApplicationtoMarketValuation 57
BewareofInterestRates 58
Example:ApplicationtotheMarketinLateSeptember2009 59