Abstract:
This paper is prepared to evaluate the market risk premium for Polish stock
exchange market. Market risk premium (MRP) is a central component of every risk return
model. Professor Ivo Welch from the University of California believes that MRP
is in the forefront of all the numbers in finance. It is the difference between the return on
stocks and risk free assets. The research is based on Capital Asset Pricing Model as it is
the one which is the most popular and most commonly used for equity premium
calculation. The main purpose of the work is to show that traditional method of estimating
MRP, with help of historical data for Polish stock market, is pointless when it comes to
accurate results and to propose alternative way to obtain it through Dividend Discount
Model (DDM). Looking at many researches gathered especially by American scientists we may say that the market risk premium based on historical data is not applicable to Polish stock exchange market as well as to other emerging markets. More and more scientific conferences discuss the issue of market risk premium
and that is why the problem is getting more significant for all the investors all around
the world. The idea of estimating MRP in Poland is not very common, that is why the
topic seems to be interesting and worth examining. To inspect market risk premium we need to use Dividend Discount Model so as to receive cost of equity for the equivalent of the market and then Capital Asset Pricing
Model for a premium itself. There are few methods for MRP evaluation but DDM is the most popular and the most recent, that is why it was used in this paper.
The work is divided into 4 chapters. The first chapter defines portfolio theory and
the background of Capital Asset Pricing Model. The second one discusses in details
market risk premium as a central component of CAPM and the most questionable
factor, as well as the ways of receiving it. The third chapter shows MRP results
prepared and published by the financial scientists for US well-developed market. The
fourth chapter is the comparison between traditional and alternative way of receiving
MRP for Polish stock exchange market.
