Ibbotson Chen Earnings Model Calculator

Ibbotson Chen Earnings Model:

\[ ERP = ((1+(I \times 0.01)) \times (1+(rEg \times 0.01)) \times (1+(Peg \times 0.01))-1+(Y \times 0.01)-(RF \times 0.01)) \times 100 \]

Expected Inflation (I):

Expected Real Growth in EPS (rEg):

Expected Changes in PE Ratio (Peg):

Expected Yield on Index (Y):

Expected Risk Free Rate (RF):

Equity Risk Premium (ERP):

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1. What is the Ibbotson Chen Earnings Model?

The Ibbotson Chen Earnings Model estimates the Equity Risk Premium (ERP) by considering expected inflation, real growth in earnings per share, changes in PE ratio, yield on index, and risk-free rate. It provides a comprehensive approach to determine the excess return expected from investing in equities over risk-free securities.

2. How Does the Calculator Work?

The calculator uses the Ibbotson Chen Earnings Model:

\[ ERP = ((1+(I \times 0.01)) \times (1+(rEg \times 0.01)) \times (1+(Peg \times 0.01))-1+(Y \times 0.01)-(RF \times 0.01)) \times 100 \]

Where:

\( I \) — Expected Inflation (%)
\( rEg \) — Expected Real Growth in EPS (%)
\( Peg \) — Expected Changes in PE Ratio (%)
\( Y \) — Expected Yield on Index (%)
\( RF \) — Expected Risk Free Rate (%)

Explanation: The model accounts for various economic factors that influence the equity risk premium, providing a more accurate estimation for investment decisions.

3. Importance of Equity Risk Premium Calculation

Details: Accurate ERP estimation is crucial for portfolio management, capital budgeting, and determining the required rate of return for equity investments.

4. Using the Calculator

Tips: Enter all values as percentages. Ensure inputs are non-negative and within reasonable ranges for accurate results.

5. Frequently Asked Questions (FAQ)

Q1: What is Equity Risk Premium?
A: Equity Risk Premium refers to the excess return that investing in the stock market provides over a risk-free rate.

Q2: Why use the Ibbotson Chen Model?
A: This model provides a comprehensive approach by incorporating multiple economic factors that influence equity returns.

Q3: What are typical ERP values?
A: Historical ERP values typically range between 3-6%, but can vary significantly based on market conditions and economic factors.

Q4: How often should ERP be calculated?
A: ERP should be recalculated periodically as economic conditions and market expectations change.

Q5: What are the limitations of this model?
A: The model relies on expected values which may be difficult to estimate accurately and may not account for all market variables.