Final answer:
The average annual risk premium on small-company stocks for the period 1926-2014 was 13.2 percent.
Step-by-step explanation:
The average annual risk premium on small-company stocks for the period 1926-2014 is 13.2 percent.
The total annual rate of return an investor would have received from buying the stocks in the S&P 500 index over recent decades was provided in Table 17.2. Considering the data from the 1950s to the 1980s, the average firm paid annual dividends equal to about 4% of its stock value. Since the 1990s, dividends have dropped and now often provide a return closer to 1% to 2%. Therefore, the risk premium on small-company stocks can be calculated as the difference between the total annual return and the average return from dividends.
For example:
- Total Annual Return = 13.58%
- Average Return from Dividends = 2%
Thus, the risk premium on small-company stocks is 13.58% - 2% = 11.58%.