The Puzzling Equity Premium Puzzle

David Merkel has some interesting thoughts on the Equity Premium Puzzle.
My so-far-ignored-by-the-Noble committee idea is that there is and should be an premium for equities, but it shouldn’t be very much. The idea is simple: If you lend a company money, both you and the company implicitly agree that they can do better with it than you. Therefore, their ROE ought to top the interest rate on the loan.
A bond can’t buy a stock, but a stock can buy a bond. Moreover, a stock can use leverage to buy even more bonds. Therefore the size of the equity premium ought to be related to the size of the yield curve. What exactly the relationship is…well, I haven’t worked that part out yet.

Posted by on July 15th, 2009 at 10:28 am


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