November 27, 2008
Singapore Gives Thanks
November 27, 2008
Thanksgiving Thoughts
November 27, 2008
Emperor, Clothes, etc.
November 27, 2008
Letter of Law, Spirit of Law
November 26, 2008
Different Forms of Government
November 26, 2008
Roderick Long and the Tiny Gnomes from Neptune
November 26, 2008
When You're in a Hole, Keep Digging
November 26, 2008
Singapore's Policy Secret: Economic Literacy, Deference, or Resignation?
November 26, 2008
Notes on McArdle's Law
Isn't focusing on the 1% figure a bit of a cop-out? Maybe the model that says there should only be a 1% gap assumes an unrealistically low level of risk aversion, but let's say the real gap at which the average investor is indifferent between the two is 3%. If it's actually 7%, that still requires explanation.
Also, couldn't one solve the equity premium puzzle simply by asking a representative sample of people who buy bonds why they do so?
You’re telling me the premium should be about 1 percent a year. Well, you wouldn’t be able to tell the difference between that and zero over a 1,000-year period.
1.01 ^ 1000 = 20,959
By what criteria is a factor of 20,959 undiscernable?
For some reason I become uncomfortable when people start banging on about a thousand years.
Is the point about 1% related to marty Weitzman's piece where he notes that if you incorporate parameter uncertainty, you get a much higher risk premium.
DeLong on Weitzman here
The point about 1% isn't about the return you'd earn over 1,000 years, but rather about our ability to observe the premium in the data - if the "true" difference were 1%, the "paradox" would be why stocks don't earn more than bonds (as you wouldn't be able to support the claim with a high degree of statistical certainty from available data).
Speaking of questionable model assumptions -
I remember a journal article a few years back in which the author noted that both long term corporate equities (stocks) and long term AAA corporate bonds had the same 7% return over some longer period of time, say 1926 – 1995. Entirely reasonable if business borrows up to no extra return. However equity investors received less than market returns due to broker, transaction, and dollar weighting costs, while bond investors had broker costs plus shorter, safer bonds, maintaining a rough equivalence of net return at the investor level of about 5%. The changing value of money comes into play based on the characteristics of the securities. Stocks reinvest part of their earnings, capturing inflation and making the net 5% a real return (8% nominal), while bonds zero reinvestment but higher cash flow loses to inflation, which at a past roughly 3% results in a 2% real bond return, reduced to 1% if corporate bonds are removed from the mix. My average investor model pretty much replicates the past US averages using only bond yield and reinvestment rate.