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Posted by jose.bailen@gmail.com on November 30, 2006, 5:01 am
Interesting. When I was at Chicago I remember several seminars on the
"equity premium puzzle": no model seems to explain in a satisfactory
way the huge difference between the long-term rate of return of stocks
(about 7 percent for big caps, in real terms), and the rate of return
of a safe asset (T-bills had an average real rate of return of less
than 0.7 percent between 1926 and 2002). Some models play with
individual preferences -the utility function- although their results
are not validated by empirical evidence, which shows a much lower risk
aversion; some other models play with a loss aversion (asymmetric
preferences, the pain of losing a given amount is greater than the
satisfaction of winning) other models play with liquidity constraints
and incomplete markets (this is the most plausible explanation in my
opinion); some other models play with trading costs, and so on...
raylopez99 wrote:
> I shelled out quite a bit of money (for my standards) and bought a new
> book Equity Risk Premium: Goetzmann and Ibbotson (2006), which is a
> collection of historical essays and journal articles with updated
> commentary.
>
> If I have time I'll post some highlights.
>
> I'm not a financial planner but the data was surprising.
>
> For example: going back to 1825 (yes!) the stock market was found to
> be quite profitable (though in the 19th century the market favored
> dividends more than capital gains, and stock prices stayed roughly
> level but gave out profits in dividends).
>
> Hence, for total return (large company stocks):
>
> >From 1825 to 1925 (geometric mean): 7.3%, with standard deviation
> (STD): 16.3%
> >From 1926 to 2005 : 10.4%
> >From 1825 to 2005: 8.6%
>
> Cross-correlation of assets are given, including real estate, corporate
> bonds, metals (Au, Ag), etc.
>
> Of interest regarding residential real estate is the low volatility
> (STD):
>
> from 1947 to 1978: residential housing: 6.88%/yr (geometric), STD =
> 3.28%! Compare with US Treasury notes: 3.7%/yr, STD = 3.71%. So real
> estate was less volatile than Treasury notes. Amazing.
>
> This review does not do justice to the book--which also gets into the
> issue of how to build models for the equity risk premium, survivorship
> bias, the global stock market, etc.
>
> Highly recommended.
>
> RL
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