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CFA Level I · CFA Level I Exam · Sources of Equity Returns

An analyst builds an equity risk premium estimate with the Ibbotson-Chen supply-side approach. Which of the following inputs is most likely used in this approach?

The Ibbotson-Chen supply-side approach builds the equity risk premium from fundamentals such as earnings growth, dividend yield and expected repricing from P/E changes, then subtracts the risk-free rate. Historical averages and surveys are distinct methods.

  1. AHistorical average of realized equity returns minus bond returns
  2. BExpected earnings growth, dividend yield, and repricing from changes in the P/E ratioCorrect
  3. CSurvey responses from investors about required returns

Explanation

Supply-side (Ibbotson-Chen) models build the expected return from fundamentals: inflation, real earnings growth, dividend yield and P/E change, less the risk-free rate. The historical approach uses realized return differences, and surveys are a separate approach.

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