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Great book on Equity Risk Premium: Goetzmann and Ibbotson

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

Reply to
raylopez99
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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...

rayl> I shelled out quite a bit of money (for my standards) and bought a new

Reply to
jose.bailen

Yeah I'm now reading the part of the book that gets into modeling. The first, and most widely quoted model, assumes the different risk premia (not the asset classes, but the risk premia) are statistically independent of each other. This "building blocks" model adds the risk premia for inflation, default, horizon, equity together, linearly.

The book mentions the problem you refer to, as the "equity premium puzzle", first pointed out in 1985 by Mehra and Prescott.

RL

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Reply to
raylopez99

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HW "Skip" Weldon

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