Estimating the Market Risk Premium in New Zealand through the Siegel Methodology

This paper estimates the standard and tax-adjusted market risk premiums in New Zealand using historical data between 1931-2002 and a variant of the Siegel (1992) methodology. Similar to Siegel we present evidence that real bond yields in New Zealand were low over the period 1931-2002 and this may bias upwards an Ibbotsontype estimate of the market risk premium. Using an estimate for the historical average of the expected real bond yield of .03-.04, then the Siegel-type estimate for the standard market risk premium in New Zealand is .03-.04, and the Siegel-type estimate for the tax-adjusted market risk premium is .055 to .062. These figures are about .02 lower than Ibbotson type estimates, and are also lower than estimates of the forwardlooking type. Our study has potential implications for the cost of equity capital and capital budgeting.