The historical and expected equity risk premium in Spain: a long-run view, 1900–2020

Abstract We present revised estimates of the historical ( ex post ) equity risk premium and an original estimate of the expected ( ex ante ) premium for the Madrid stock market over a period of 120 years. The results are based on a new equity index, the H-IBEX (1900–1987), built on high-quality monthly data hand-collected from primary sources and methodologically aligned with the modern Spanish index, IBEX35 (1988–2020). We also reconstructed for the same period an original weighted index of government bonds which can be smoothly spliced with recent data. We find that previous estimates based on existing data overestimated equity returns and underestimated bond returns, thus leading to a biased estimate of the risk premium. Our data suggest that the reward for excess risk earned by Spanish investors in the long run was significantly below the European average and more aligned with the experience of poor-performing markets, such as Paris and Brussels, especially before 1936 and after 1980. Exploiting the forecasting power of the dividend-price ratio, both in-sample and out-of-sample, we also use a dynamic dividend growth model to estimate the time-varying expected excess return of equities for investment horizons from 12 to 60 months. In line with theoretical expectations, we find that fluctuations in the expected risk premium were correlated with periods of heightened uncertainty driven by financial instability.