Revenue Recognition
ESTIMATING THE RISK PREMIUM USING HISTORICAL DATA: A CASE OF THE NSE
Introduction
This study seeks to estimate the risk premium of a company using historical data. Analysts use historical data to estimate the risk premium of a company’s equity. This is because the historical data is readily available from the company’s financial statements and the securities exchanges for example the Nairobi Stock Exchange (NSE) in Kenya. Historical market data can be used to compute average returns and a measure of risk or volatility. The distribution of past returns can be useful in estimating the possible future returns for investors.
Required Rate of Return Estimate
The required rate of return has two basic components: the risk free interest rate and a risk premium. The return earned by investors should compensate them for the risk of the investment. We must estimate future risk premiums to determine the stock’s current intrinsic value. Estimates of nominal risk free interest rates are available from the initial analysis of the economy. The risk premium of a firm must rely on other information including evaluation of the financial statements and capital market relationships.
You should compare the ratios that measure business risk, financial risk, liquidity risk, exchange rate risk and the country risk of the firm with those of the industry, the overall market, other firms in the industry, or firm’s historical premium. For a market based risk estimate, the firm’s characteristic line is estimated by regressing market returns on the stock’s returns. The slope of the regression line is the stock’s measure of the firm’s systematic risk. Beta is affected by changes in a firm’s business and financial risks as well as other influences. You should lower or increase the historical beta estimate based on the analysis of the firm’s risk characteristics.
Computing Historical Returns
Realized Return = Dividend yield + Capital yield
[pic]
Where:
Rt+1 -Realized
Introduction
This study seeks to estimate the risk premium of a company using historical data. Analysts use historical data to estimate the risk premium of a company’s equity. This is because the historical data is readily available from the company’s financial statements and the securities exchanges for example the Nairobi Stock Exchange (NSE) in Kenya. Historical market data can be used to compute average returns and a measure of risk or volatility. The distribution of past returns can be useful in estimating the possible future returns for investors.
Required Rate of Return Estimate
The required rate of return has two basic components: the risk free interest rate and a risk premium. The return earned by investors should compensate them for the risk of the investment. We must estimate future risk premiums to determine the stock’s current intrinsic value. Estimates of nominal risk free interest rates are available from the initial analysis of the economy. The risk premium of a firm must rely on other information including evaluation of the financial statements and capital market relationships.
You should compare the ratios that measure business risk, financial risk, liquidity risk, exchange rate risk and the country risk of the firm with those of the industry, the overall market, other firms in the industry, or firm’s historical premium. For a market based risk estimate, the firm’s characteristic line is estimated by regressing market returns on the stock’s returns. The slope of the regression line is the stock’s measure of the firm’s systematic risk. Beta is affected by changes in a firm’s business and financial risks as well as other influences. You should lower or increase the historical beta estimate based on the analysis of the firm’s risk characteristics.
Computing Historical Returns
Realized Return = Dividend yield + Capital yield
[pic]
Where:
Rt+1 -Realized