Economic vs. Equity Risk

When examining the impact of macroeconomic factors on the price of equity risk, research sometimes yields contradictory results. For instance, a solid correlation between high inflation and market risk premium is often not found.

On the other hand, take a look at the correlation between GDP growth rate volatility and the Equity Risk Premium, as shown in the graph.

It appears that the price of risk is more influenced by the uncertainty of conditions rather than their scale. In other words, the more predictable the indicators of economic growth, employment, and inflation, the less risky the market perceives investments to be.

Source:

*Equity Risk Premiums (ERP): Determinants, Estimation and Implications – The 2013 Edition Updated: March 2013; Aswath Damodaran; Stern School of Business