India stocks: Equity Risk Premium

In case  some of you are wondering about my 20% discount rate in the post: India Stocks: Bank Nifty offering good value

I have used the work of Varma/Barua June 2006 where good work was done in re-creating data series to allow a robust calculation of an equity risk premium for India.  They came up with 12.5% ERP and I have used a 7.5% risk free rate going forward...so we have a 20% discount rate.

The overall indices can also be ball-parked using this method.  If we assume:

• 10% reduction in EPS for the indices in 2009-2010
• 15% earnings growth rate for next 10 years and 10% thereafter
• Discount rate of 20%

Then we get the following fair values for the Indices:

                        Nifty   2460     Sensex     8600