ssrn-id892231 - CRACOW UNIVERSITY OF ECONOMICS Working...

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C RACOW U NIVERSITY OF E CONOMICS Working Paper: General Accounting Theory, No. 82/KR/1/2005/S/254 December 2005 N ATURE AND S IZE OF THE R ISK P REMIUM Mieczyslaw Dobija Faculty Management, CUoE
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Abstract Capital is an ability of doing work. This is abstract and homogenous category, which has its equivalent in physics as concept of energy. Therefore the second law of thermodynamics predetermines an existence and a size of the risk premium as an essential economic constant, which shapes interest and discount rates, wages and salaries, prices of goods and rate of returns under conditions of free market exchanges. A free market assigns for successful workers, entrepreneurs and investors a premium for risk in order they could maintain their capital at invested level at least. A rate of natural dispersion of capital influences the most size of the risk premium because it must be sufficient to cover this rate. Preventing to the random dispersion of capital by well arranged management system an economic unit can create profit by limiting costs of risk and saving the market risk premium. The risk premium is a benchmark for fair, just prices. 1. Problem setting Equity capital is analogous to economic energy under control of the owner and value must be understood as a concentration of energy in objects. Each object – physical or legal – needs energy for its existence. This energy has to be measured in order to check that it is maintained, not wasted and this is the aim of our accounting system that measures capital and its changes. It is principle of conservation energy as its very background. Capital (energy) does not arise from nothing; in context of business unit it is the premise of double-entry accounting, which its capacity of measuring of periodic profit. Therefore accounting systems are essential to help investors, managers and entrepreneurs to evaluate the continuation of existence of a business or of an entire economy. Nobody conducts enterprise in order to waste capital. The second law explains however that capital has spontaneous tendency for dispersion. It is random, but unavoidable process. Free market enables to all participants setting off this dispersion awarding them with the risk premium. Therefore the risk premium as an essential economic category manifests in theory of finance, theory of capital, and in human capital considerations. Theories of discount rates include mostly some concept of risk premium. Some significant opinions, well representing state of art, in the USA at least, have been introduced during „Research Roundtable Discussion: The Market Risk Premium” conducted by I. 2
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Welch (2000). According to the most of discussant the risk premium is still vague and undetermined. I. Welch has introduced the main questions as follows: “There are three inter-related questions of primary interest to researchers: [1] Why has the historical equity premium been so high? [2] What is a good forward-looking prediction for the equity premium for the long
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ssrn-id892231 - CRACOW UNIVERSITY OF ECONOMICS Working...

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