Thanks for your question. You are right about arriving at the Risk free rate subtracting the CD spread from the 10Y bond. In this part of the post, I just used the most commonly used method to compute erp, where you take the earnings yield of sp500 and subtract it from the bond yield. I am personally, not a huge fan of this method. In Part 2 of this post (https://amritaroy.substack.com/p/equity-risk-premium-part-2-where), I take the approach where I estimate the cashflows of sp500 over the next 5 years and beyond and use it to compute the expected rate of return that the index is currently pricing in and subtract it from 10y to arrive at the erp, which as of the writing (a month ago) stood at 4.68%, not near lows, not near highs either. Hope this helps. Let me know if you have any followup questions.
As I understand, we must also reduce the CD Spread from 10Y bond to arrive at Risk Free Rate. This may be push up the ERP above 1% in this computation
I may be wrong also.
Thanks for your question. You are right about arriving at the Risk free rate subtracting the CD spread from the 10Y bond. In this part of the post, I just used the most commonly used method to compute erp, where you take the earnings yield of sp500 and subtract it from the bond yield. I am personally, not a huge fan of this method. In Part 2 of this post (https://amritaroy.substack.com/p/equity-risk-premium-part-2-where), I take the approach where I estimate the cashflows of sp500 over the next 5 years and beyond and use it to compute the expected rate of return that the index is currently pricing in and subtract it from 10y to arrive at the erp, which as of the writing (a month ago) stood at 4.68%, not near lows, not near highs either. Hope this helps. Let me know if you have any followup questions.
This is an excellent analysis, Amrita.
Thanks, glad you enjoyed the post.