[PEN-L:12022] re: equity premium puzzle

[Doug Henwood <dhenwood@xxxxxxxxx>]

James Devine wrote:

>I'm no finance economist, but I think the distinction might be defined
>better in terms of his phrase the "general gambling/insurance premium." Or
>maybe it could be explained in terms of uncertainty: there's more risk to
>the equity market that can't be avoided via diversification than there is
>in the bond market. I'll ask Chuck, which is easier than finding & reading
>the Shiller references.

If you're talking uncertainty in the Keynesian sense, then you're a long
way from mainstream finance theory.

I used the equity premium puzzle in part to undermine the social security
privatization argument - that if finance theory can't explain historical
stock returns, returns well above GDP or even profit growth, it takes a
deep faith to believe that past performance is a guide to future returns.
The privatizers' financial assumptions require a persistent inflation of
P/E's - Dean Baker's worked it out to 450 or something like that in 50
years or so.

>well, if people don't like volatility and the stock market is relatively
>volatile, wouldn't that drive people away from buying stock unless the
>return in the stock market were higher in the long run?

Yeah but when and how is that enforced? In bear markets, which are, it must
be conceded, rare? Money keeps going into stocks (in important part from
nonfinancial corps buying in their own shares and those of their M&A
targets). Most active investors today have never seen a bear market. In
today's Wall Street, radical uncertainty is rated at 0, and ordinary market
risk just the mildest thing.

Doug