Given the market’s outlook for corporate earnings – as embodied, for example, in the predictions of market analysts – we make a crude estimate of the risk premium on equities as the difference between the ratio of trend earnings to price and a real long-term Treasury yield.
On occasion, we go further and use structural economic models to decompose the risk premium into components related to risk and to investors’ risk appetite. In the credit market, the relevant future cash flows are the coupons on corporate debt, less an allowance for expected losses from future defaults.