The US equity risk premium, the extra return investors can expect for buying US stocks instead of riskfree government bonds, has fallen to its lowest levels of the past decade by some measures, as the fiery stock market rally stretches valuations. Investment strategists have pointed to the indicator to justify a more cautious approach to US equities, which set a record high last week. The equity risk premium for the S&P 500 index was ‘about as low as it can go’, Morgan Stanley analysts wrote in a recent note to clients, arguing that investors were not compensated sufficiently for the risk of owning equities rather than Treasuries.

1. Critically discuss whether the equity risk premium can be predicted accurately.

2. What have been the implications of the recent economic recession reducing the US equity risk premium to its lowest level over the last decade.