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In The Risk Premium Factor: A New Model for Understanding the Volatile Forces That Drive Stock Prices, Stephen D. Hassett presents a radical new theory—the "factor" that explains theentire stock market, providing a definitive link between loss aversion theory, the equity risk premium, and stock price, and shows how you can make the most of the connection.
Where others have tried and failed to find a link between loss aversion and the processes that control how investors set prices in the stock market, The Risk Premium Factor succeeds. Demonstrating that the equity risk premium is proportional to long-term Treasury yields, the book establishes for the first time a quantitative connection between loss aversion and equity risk premium.
This remarkable new concept can be used to explain stock prices from 1960 through to the present day, including the 2008 financial meltdown, not through theories and simulations, but with historical data that bear out the truth. It shows how the S&P 500 has consistently reverted to predicted values and solves the equity premium puzzle by showing that it is consistent with findings on loss aversion. Putting you back in the driver's seat when it comes to investing, the book clearly demonstrates the stock market's reptilian-like response to three factors drive valuation and stock price: earnings, long-term growth, and interest rates. This book also includes a companion website with historical data, calculators, and links to additional apps and readings.
Dispelling the notions that the stock market is a mysterious arbiter of value, when, in fact, it is easy to understand the Risk Premium Factor Valuation Model is a game-changer for anyone who works in investments—from professional investors to corporate decision makers to private individuals. After all, if you don't understand how the market values businesses, you don't really understand the market at all.
"Stephen Hassett is onto something. His notion that the risk premium on stocks is not constant, but varies with the risk free rate, helps to explain an enduring puzzle: why actual stock prices vary from the estimates that analysts' models imply. This book will offer fresh and provocative insight to careful students of the stock market. Read it and grow wiser."—Robert F. Bruner, Dean and Charles C. Abbott Professor of Business Administration, Darden Graduate School of Business, University of Virginia
"The equity risk premium is a key input to the cost of capital. During periods of economic stability, practitioners typically used an estimate of the long-term average equity risk premium, typically adjusting the estimate once a year. But all that changed as the crisis in late 2008 unfolded. In these uncertain economic times, we have found the Risk Premium Factor Valuation Model to be a powerful tool for adjusting our equity risk premium estimate as we move through the rapidly changing business cycle. We recommend that practitioners use the Risk Premium Factor Valuation Model to better understand the economic interrelationships that drive the pricing of the broad stock market and the equity risk premium."—Roger J. Grabowski, Managing Director, Duff & Phelps LLC and coauthor of Cost of Capital: Applications and Examples
"Understanding and accurately estimating the cost of capital is fundamental to making decisions that create value. Stephen Hassett's Risk Premium Factor Valuation Model provides an easy-to-understand approach to estimating the cost of equity capital that is accessible and insightful to those with a basic understanding of finance and expert practitioners alike. Further, it demystifies the drivers of market valuation and provides a compelling and often under-appreciated linkage between growth and stock price. It will enrich the perspective of any investor or manager."—David M. Kostel, Managing Director and Co-Head of Healthcare Mergers & Acquisitions, Credit Suisse