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Thursday, September 29, 2005


Don Lloyd

I find it strange that the economic, political and demographic environment for a given dataset can simply be ignored. Is it not worth at least a mention that stocks and government bonds have recorded long term returns that move in opposite directions in the face of increasing demand for investments of all kinds?


Regards, Don

Peter Vermeulen

Morgan Stanley has presented a valuation for equities based on Barro's paper. It is in the September 12 weekly (of David Miles, Vladimir Pilonka and Melanie Baker): What Hould Equities Be Worth in a Risky World.

I think the theory of barro is in agreement with the behavioral finance theory of James Montier (of Dresdner K.B.>). He states that humans have two kinds of reactions: slow ones based on the rational part of our brains and fast ones based on the emotional part of our brains.
This fast part have all animals. It is necessary for animals to take care for extremely dangerous rare events to survive. It is better to fly 100 times for danger that after scrutiny wasn't so dangerous than to forget one time to fly when the animal is eaten or something else that is fatal.
For your invested money to survive for a very long time (for example 50 years) it is also necessary to take care for extreme events. If you lose everything it is often no longer possible to get rich again. Over a time period of one year it is very unlikely that a rare event will happen, but over a time span of 50 years this kind of events that Barro present have a probability of maybe 30% or maybe higher.
So it is quite natural that also humans give exteme weight to very dangerous events. And of course, you can make money when you have the time to find out at a rational way that the danger doesn't exist or is exaggerated (for example after a terrorist attack)

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Ben Sykes

See the paper by Yogo in the April 2006 volume of the Journal of Finance. Yogo appears to nail the premium down.


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I believe this information.....It's not quite the holy grail of financial economics, but certainly one of the longest running debates has been over what is known as the equity premium puzzle - or why US stock returns are so much higher than returns on Treasury bonds

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