Great book on Equity Risk Premium: Goetzmann and Ibbotson

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

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

snipped-for-privacy@gmail.com wrote:

A free, recent, and very informative article on the equity premium is Dimson, Marsh, and Staunton, "The worldwide equity premium: a smaller puzzle" at

David

I heard about this book, but it costs $75 and it's hard to find (according to Amazon), but I think part of it is covered in the book I have (regarding world markets and survivorship bias)

RL

Other resources can be found on this newsgroup's FAQ located at

-HW "Skip" Weldon Columbia, SC

Update: This paper by Dimson, Marsh and Staunton is informative but a bit too optimistic about worldwide equity returns over the last 100 years.

For example, Table I of Dimson is grossly in error, according to the data in the Goetzmann and Ibbotson book, chapter 16, "Global Stock Markets in the 20th Century". The real equity returns in the Dimson paper are wildly biased upwards (every single country shows upwards bias from what's reported in Goetzmann et al). For example, Belgium had a -0.26%/yr return says Geotzmann from 1921 to 1996 while Dimson reports 2.4%/yr. The years are a bit off (1921 to 1996 for the former and '1900' to 2005 for the latter--and every single country has a '1900' value, when Goetzmann specifically says finding good data that far back in every country is a problem) but if anything World War I should have hurt Belgium even more, and I can't imagine the years

RL

David Moore wrote:

Update to the update: apparently, rereading the paper, Dimson, Marsh and Staunton refer to chap 16 of the Goetmann et al article (by Jorion and Goetzmann) and claim the J&G article is biased too low since it excludes foreign stock market dividends. If true, then I guess Dimson et al are right after all.

RL

rayl> Update: This paper by Dimson, Marsh and Staunton is informative but a