Abstract

Examinations of long-run trends in the stock market usually concentrate on markets in the United States. This paper builds on these studies by examining the equity risk premium in Canada over the 1923-2001 period. Two methodologies are used to gauge the expectations of investors with regard to the equity risk premium. The first is the one developed and implemented by Arnott and Bernstein (2002) for the United States. The second methodology estimates the equity risk premium implicit in the discount rate that equates forecasted dividend payments to present market valuations. The empirical results show that actual risk premiums either met or exceeded the future equity risk premium expectations of Canadian investors over the studied time period. On balance, it would appear that investors realized more than they expected in terms of risk premium over the studied period, although this excess does not appear to be as pronounced as that found by Arnott and Bernstein (2002) for the United States. Moreover, evidence is presented that the effect of the stock exchange (namely, the Toronto Stock Exchange and Montreal Exchange) used to measure stock returns is important when investors form their expectations regarding future equity premiums. However, the latter result may be due to the lower quality of the data available for the Montreal Exchange.