US Equity Risk Premiums during the COVID-19 Pandemic

I’ve recently completed a research study

US Equity Risk Premiums during the COVID-19 Pandemic ,

available at This work is a follow-up application of my recent work on

Option-based Equity Risk Premiums, which I posted about here:

The Term Structure of the Equity Risk Premium

The equity risk premium (ERP) is the extra return (above Treasury rates) that investors expect, in order to hold stocks. The health and financial distress associated with the pandemic has been enormous. This has led to record-setting volatility and likely record-setting ERP’s also.  At any point in time, the ERP term structure is a chart of the equity risk premium (as an annual percentage rate) at various time horizons. My time horizons range from one day ahead to about 3 years.

To give a bit of a preview, consider the early days of the pandemic, shown in the timeline below (click on snapshot to view):

Time Line 1
Early timeline events during the COVID-19 pandemic


At this point in time, the US equity market was not too concerned, volatility was more-or-less normal and the associated ERP term structure looked as follows:

US ERP Term Structure on Jan 22, 2020

That January 22 chart shows the ERP’s in a 3-6% range: typical of an unstressed market, and also characteristic of long-run (unconditional) ERP’s. The dotted lines are my point estimates and the gray areas reflect an estimated uncertainty interval.  The main driver of the uncertainty is the degree of risk aversion in a so-called “representative investor”.

Notice that I am using a logarithmic scale for the time axis. The reason for this is that the times are actually the times to various S&P 500 Index option expirations. Those are very closely spaced in the first 30 days ahead. The log scale effectively spreads them apart for greater visibility.

By mid-March 2020, the pandemic had become global, cases and deaths were growing exponentially, and financial markets were close to panic mode. The ERP term structure dramatically inverted:

US ERP Term Structure on Mar 12, 2020

At the short-end of the curve, investors now required an annualized expected return of 500-600% in order to hold equities. This is likely a record, although to say for sure would require applying my same methods to option data during the 2008-2009 Financial crisis. This has not yet been done.







2 thoughts on “US Equity Risk Premiums during the COVID-19 Pandemic”

  1. Alan,

    Nice work on both the term structure of ERP and how COVID-19 is impacting this term structure. I was hoping to see an update of your paper with some more recent data. BestEx had a nice piece on US Equity Liquidity in the COVID-19 Crisis in March that was followed up in May. The signs suggested that the impact of COVID on trading costs had subsided substantially. Your Figure 14 suggest that as of April 15 there was an expected uptick in the ERP at the long end of the 2-5 term despite a continued contraction of ERP over the 0-2 period. This uptick is not picked up in Figure 10 or Figure 12 just one month earlier. I would love to see a three dimensional ERP map over February-July to see how the ERP term shifted over this time period. Would be very helpful in thinking about whether to incorporate a change in ERP in valuations conducted during the window.

    1. Thanks for your comment, Andrew. I expect to update that paper — not sure when I will get to it.
      You’re right on that uptick. Good suggestion on having a 3D chart.

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