equity premium

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Expected Returns: An Investor's Guide to Harvesting Market Rewards by Antti Ilmanen

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I will discuss both measures, ERPC and ERPB, in the context of both nominal and real (inflation-adjusted) returns. This entire analysis focuses on pretax returns [1]. The other important distinction among equity premium concepts is between the ex post equity premium (historical realized excess return) and the ex ante equity premium (forward-looking excess return):• both can be measured either as an arithmetic average or a geometric average; • the latter may be based on objectively feasible future returns (rational expectations) or subjective return expectations (that are possibly irrational). Thus, the label “ERP” can be misleading if non-risk considerations cause equities’ ex ante return advantage. The equity premium is ideally computed for stock market indices that weight each constituent stock by its market capitalization. Early research also analyzed equally weighted stock indices that effectively overweight small-cap stocks and require frequent turnover to maintain equal weights.

They focus on a more direct measure of relative sentiment and show that when the share of retail investable wealth held in equity relative to the share of total investable wealth held in equity is high (low), subsequent stock market returns tend to be low (high). Academics. Even academic views on the equity premium have evolved during the past decade—perhaps reflecting a shift from basing equity premium estimates on historical average returns to basing them on forward-looking analysis like the DDM. Ivo Welch has polled hundreds of finance professors about their view on the equity premium on four occasions: 1997–1998, August 2001, December 2007, and January 2009. His main survey question focuses on the (arithmetic) 30-year equity premium (over short-dated Treasury bills, so the premium is slightly higher than the equity–bond premium). The mean premium fell from the first survey’s 7% to 5.5% in 2001, then edged up to 5.7% in 2007 and 6.0% in 2009.

• Equity market valuations have been especially high amidst stable mild inflation and low macro-volatility, which is not a promising sign for future multiple expansion. • Standard economic models suggest that the equity premium should be negligible (<1%). A cottage industry of academic papers offers diverse explanations for the puzzle of stocks’ much stronger historical outperformance. • Survey forecasts of equity premia vary across sources and over time. Retail investor expectations appear extrapolative and procyclical, professional investor views less so. The latter tend to predict a long-run equity premium of 3% to 4%—below the historical average but above some estimates from valuation models. Academics’ estimates average near 6%, the higher value apparently reflecting benign 20th-century experience and/or the widespread use in academia of the future-equals-past model for the equity premium. • Valuation, cyclical, and sentiment indicators can be useful for market timing, but all such relations are fragile. 8.1 INTRODUCTION AND TERMINOLOGY It is natural to begin the analysis with the asset class perspective and with the reward for stock investing, traditionally the most important source of long-run excess returns (see cube).

Stocks for the Long Run, 4th Edition: The Definitive Guide to Financial Market Returns & Long Term Investment Strategies by Jeremy J. Siegel

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These projected real returns are lower than the 31⁄2 percent average compound real return on U.S. longterm government bonds over the past 205 years, but they are not as low as they were during the postwar period. The excess return for holding equities over short-term bonds is plotted in Figure 1-5, and it is referred to as the equity risk premium, or simply the equity premium.16 The equity premium, calculated as the difference in 30-year compound annual real returns on stocks and bills, averaged 1.4 percent in the first subperiod, 3.4 percent in the second subperiod, and 5.9 percent since 1926. The abnormally high equity premium since 1926 is certainly not sustainable. It is not a coincidence that the highest 30-year average eq16 For a rigorous analysis of the equity premium, see Jeremy Siegel and Richard Thaler, “The Equity Premium Puzzle,” Journal of Economic Perspectives, vol. 11, no. 1 (Winter 1997), pp. 191–200, and more recently, “Perspectives on the Equity Risk Premium,” Financial Analysts Journal, vol. 61, no. 1 (November/December 2005), pp. 61–73, reprinted in Rodney N.

As stocks become more liquid, their valuation relative to earnings and dividends should rise.12 The Equity Risk Premium Over the past 200 years the average compound rate of return on stocks in comparison to safe long-term government bonds—the equity premium—has been between 3 and 31⁄2 percent.13 In 1985, economists Rajnish Mehra and Edward Prescott published a paper entitled “The Equity Premium: A Puzzle.”14 In their work they showed that given the standard models of risk and return that economists had developed over the years, one could not explain the large gap between the returns on equities and fixed-income assets found in the historical data. They claimed that economic models predicted that either the rate of return on stocks should be lower, or the rate of return on fixed-income assets should be higher, or both. In fact, according to their studies, an equity premium as low as 1 percent or less could be justified.15 Mehra and Prescott were not the first to believe that the equity premium derived from historical returns was too large.

When I look at stocks in the very short run, they seem so risky that I wonder why anyone holds them. But over the long run, the superior performance of equities is so overwhelming, I wonder why anyone doesn’t hold stocks! IC: Exactly. Shlomo Bernartzi and Richard Thaler claim that myopic loss aversion is the key to solving the equity premium puzzle.27 For years, econ26 Shlomo Bernartzi and Richard Thaler, “Myopic Loss Aversion and the Equity Premium Puzzle,” Quarterly Journal of Economics, 1995, pp. 73–91. 27 See Chapter 8 for a further description of the equity premium puzzle. CHAPTER 19 Behavioral Finance and the Psychology of Investing 333 omists have been trying to figure out why stocks have returned so much more than fixed-income investments. Studies show that over periods of 20 years or more, a diversified portfolio of equities not only offers higher after-inflation returns but is actually safer than government bonds.


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Misbehaving: The Making of Behavioral Economics by Richard H. Thaler

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Shlomo and I were interested in an anomaly called the equity premium puzzle. The puzzle was first announced, and given the name, by Raj Mehra and Edward Prescott in a 1985 paper. Prescott was a surprising person to announce an anomaly. He was and remains a hard-core member of the conservative, rational expectations establishment. His work in this domain, called “real business cycles,” would later win him a Nobel Prize. And unlike me, Prescott did not have declaring anomalies as part of his agenda. I suspect he found this one to be a bit embarrassing given his worldview, but he and Mehra knew they were on to something interesting. The term “equity premium” is defined as the difference in returns between equities (stocks) and some risk-free asset such as short-term government bonds. The magnitude of the historical equity premium depends on the time period used and various other definitions, but for the period that Mehra and Prescott studied, 1889–1978, the equity premium was about 6% per year.

The magnitude of the historical equity premium depends on the time period used and various other definitions, but for the period that Mehra and Prescott studied, 1889–1978, the equity premium was about 6% per year. The fact that stocks earn higher rates of return than Treasury bills is not surprising. Any model in which investors are risk averse predicts it: because stocks are risky, investors will demand a premium over a risk-free asset in order to be induced to bear that risk. In many economics articles, the analysis would stop at that point. The theory predicts that one asset will earn higher returns than another because it is riskier, the authors find evidence confirming this prediction, and the result is scored as another win for economic theory. What makes the analysis by Mehra and Prescott special is that they went beyond asking whether economic theory can explain the existence of an equity premium, and asked if economic theory can explain how large the premium actually is.

.† After crunching the numbers, Mehra and Prescott concluded that the largest value of the equity premium that they could predict from their model was 0.35%, nowhere near the historical 6%.‡ Investors would have to be implausibly risk averse to explain the historical returns. Their results were controversial, and it took them six years to get the paper published. However, once it was published, it attracted considerable attention and many economists rushed in to offer either excuses or explanations. But at the time Shlomo and I started thinking about the problem, none of the explanations had proven to be completely satisfactory, at least to Mehra and Prescott. We decided to try to find a solution to the equity premium puzzle. To understand our approach, it will help to consider another classic article by Paul Samuelson, in which he describes a lunchtime conversation with a colleague at the MIT faculty club.


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Portfolio Design: A Modern Approach to Asset Allocation by R. Marston

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asset allocation, Bretton Woods, capital asset pricing model, capital controls, carried interest, commodity trading advisor, correlation coefficient, diversification, diversified portfolio, equity premium, Eugene Fama: efficient market hypothesis, family office, financial innovation, fixed income, German hyperinflation, high net worth, hiring and firing, housing crisis, income per capita, index fund, inventory management, Long Term Capital Management, mortgage debt, passive investing, purchasing power parity, risk-adjusted returns, Robert Shiller, Robert Shiller, Ronald Reagan, Sharpe ratio, Silicon Valley, superstar cities, survivorship bias, transaction costs, Vanguard fund

The excess return of stocks over the risk-free return has been given a specific name, the equity premium. Using geometric averages, the equity premium is defined as Equity premium = (1 + rS&P )/(1 + rF ) − 1 = (1 + 0.107)/(1 + 0.048) − 1 = 5.6% where rS&P is the return on the S&P 500 and rF is the risk-free Treasury bill return.5 Sometimes the equity premium is defined by using the long-term bond rather than the risk-free return in which case the premium would be 4.4 percent rather than 5.6 percent. If the entire period from 1926 to present is studied, a period that includes the depression of the 1930s, the equity premium (defined relative to the risk-free return) is 5.9 percent. However it is defined, the equity premium is remarkably large. This premium has provided equity investors with a rich reward for bearing the extra risk of owning equities.

In a landmark study more than two decades ago, Mehra and Prescott (1985) showed that the equity premium is inconsistent with reasonable levels of risk aversion. They called the premium a puzzle. Since then, scores of finance researchers have set out to develop theoretical models of investor behavior that could explain the size of the premium.6 Researchers have also studied the equity premium in other countries. A book by Dimson, Marsh, and Staunton (2002) estimates the equity premium for 16 industrial countries from 1900 to 2000 as ranging P1: OTA/XYZ P2: ABC c02 JWBT412-Marston December 20, 2010 16:59 Printer: Courier Westford 24 PORTFOLIO DESIGN from 1.8 percent for Denmark to 7.4 percent for France, with an average equity premium of 4.9 percent. Wise investors don’t spend too much time agonizing over the source of the premium.

The longer historical record, however, certainly raises questions about whether Treasuries should be the primary foundation of a long-term portfolio. Consider the average real return on Treasuries over the full sample period. From 1951 through March 2009, the long-term Treasury bond had a compound return of 2.4 percent/year adjusted for inflation. During the same time period, U.S. large-cap stocks had a compound real return of 6.2 percent. The difference between these two returns is often called the “equity premium”. Chapter 2 will discuss this equity premium in detail. The period prior to 1951 was no better. The real return on bonds between 1926 and 1950 was 2.7 percent, while the real return on stocks was 6.3 percent. And this period included the Great Depression! Investors who are currently enamored with bonds had better know the truth about the long-run return on bonds. It’s terribly low. And it is not the basis for long-run wealth accumulation.


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Efficiently Inefficient: How Smart Money Invests and Market Prices Are Determined by Lasse Heje Pedersen

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Hence, a typical stock with a 2% dividend yield and a 3.5% dividend growth rate has an expected return of 5.5% over the long term. We can further compute the equity premium, that is, the expected return on equities in excess of the risk-free rate. The equity premium is important because it tells by how much equities are expected to beat cash and it should be viewed as the current market compensation for the risk in equities. Of course, the equity premium depends both on the expected equity return and the current risk-free interest rates. Given that the current interest rates are near zero, this means that the equity premium is also about 5.5%, under the same assumptions as above. A more typical nominally risk-free interest rate might be around 3 to 4%, that is, a 1 to 2% real rate plus 2% inflation. With an interest rate of 3%, the equity premium would only be 2.5% under the maintained assumptions, but of course, all these numbers are subject to significant uncertainty.

A one percentage point higher dividend yield translates into a 2.3 percentage point higher estimated expected price appreciation such that the total equity premium increases by 3.3 percentage points. The t-statistic of the estimate is 2.8, indicating that the coefficient appears significantly different from zero,3 but the estimated standard error of 1.2 also means that the coefficient could really be anywhere between 3.3 − 2 × 1.2 = 1 and 3.3 + 2 × 1.2 = 6, a wide range. The estimated coefficients imply that the equity premium varies significantly as the dividend changes over time. For instance, the lowest observed dividend yield of 1.1% happened in 2000 during the height of the Internet bubble. Based on the regression estimates, this translates into an equity premium of . The highest observed dividend yield of 13.8% happened during the stock market trough of 1932, implying an equity premium of 41%. Figure 10.1.

With an interest rate of 3%, the equity premium would only be 2.5% under the maintained assumptions, but of course, all these numbers are subject to significant uncertainty. The historical U.S. equity premium over cash has been about 7 to 8% per year from 1926 to 2013, but it has been lower in most other countries. This high historical U.S. equity premium can be decomposed as follows: The historical average dividend yield was 3.9%, almost double its current value. The dividend growth rate was 4.6%, higher than my estimate above due to higher historical inflation of about 3%. The price appreciation due to valuation change has been substantial, 2.4%, due to the increase in the price-dividend ratio (and to a convexity effect associated with arithmetic averages of returns with time-varying valuation ratio).5 The average adjustment term is small (about 0.15%). The average risk-free rate has been 3.5%, implying a low average real rate.

Investment: A History by Norton Reamer, Jesse Downing

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Prospect theory contends that individuals’ choices are more centered on changes in utility or wealth rather than end values; it also suggests that most people exhibit loss aversion in which losses cause more harm to one’s welfare than the benefit from happiness one receives from gaining the same amount of reward.46 This theory may seem intellectually interesting, but how does it relate precisely to finance and investing? Since Kahneman and Tversky’s seminal paper, subsequent work has made many connections to markets, one of which is the “equity premium puzzle.” The equity premium puzzle was described first in a 1985 paper by Rajnish Mehra and Edward Prescott.47 The central “puzzle” is that while investors should be compensated more for holding riskier equities than holding the risk-free instrument (Treasury bills), the amount by which they are compensated seems extremely excessive historically. In other words, it seems that equity holders have been “overpaid” to take on this risk.

Over long evaluation periods, The Emergence of Investment Theory 253 however, where market movements have a general upward trend, this feeling of loss aversion is reduced because equities tend to appreciate over time, so it is more palatable to hold on to equities. The size of the equity premium, then, is really due to loss aversion experienced by investors whose frequency of evaluations is too great; if investors looked at their equities portfolios over longer time frames, they would demand lower premiums and this puzzle would be resolved.49 Other explanations that have been offered by behavioral economists focus on earnings uncertainty and how that influences investors’ willingness to bear risk, and yet others develop a dynamic loss aversion model where investors react differently to stocks that fall after a run-up compared to those that fall directly after purchase. Another place where this behavioral lens has been applied to financial markets beyond the equity premium puzzle is momentum. Recent work has looked at momentum in the markets by analyzing serial correlations through time.

Warren Buffett, “The Superinvestors of Graham-and-Doddsville,” Hermes (Columbia Business School), Fall 1984, 4–15. 46. Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decision under Risk,” Econometrica 47, no. 2 (March 1979): 265–278. 47. Rajnish Mehra and Edward C. Prescott, “The Equity Premium: A Problem,” Journal of Monetary Economics 15, no. 2 (March 1985): 145–161. 48. Stephen J. Brown, William N. Goetzmann, and Stephen A. Ross, “Survival,” Journal of Finance 50, no. 3 (July 1995): 853–873. 49. Shlomo Benartzi and Richard H. Thaler, “Myopic Loss Aversion and the Equity Premium Puzzle,” Quarterly Journal of Economics 110, no. 1 (February 1995): 73–92. 50. Burton G. Malkiel, “The Efficient Market Hypothesis and Its Critics,” Journal of Economic Perspectives 17, no. 1 (Winter 2003): 61–62. 8. MORE NEW INVESTMENT FORMS 1. Towers Watson and Financial Times, “Global Alternatives Survey 2012,” last modified July 2012, http://www.towerswatson.com/en-US /Insights/IC-Types/Sur vey-Research-Results/2012/07/Global -Alternatives-Survey-2012, 7–8. 2.

Culture and Prosperity: The Truth About Markets - Why Some Nations Are Rich but Most Remain Poor by John Kay

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These market anomalies cast doubt on the claim that the price of risky assets incorporates all publicly available information. Stocks fell by over 20% on October 19, 1987. On July 15,2002, they dropped by 5% in the morning and rose 5% in the afternoon. These movements could not possibly be explained by new information about company prospects. The most important market anomaly is that the "equity premium"-the historic difference between the return on stocks and shares and the return on risk-free assets-seems much too high. As financial economists have debated the "equity premium paradox," estimates of the size of the premium have fallen. 7 Even so, an average return of 4% to 5% over safe assets seems far more than is needed to compensate for extra risks. If equity returns were indeed so high, shares would almost certainly outperform bonds over all but the shortest periods of time.

Glossary { 363} Falling average costs of production that are the result of higher levels of output. efficient market hypothesis The theory that information about the past and future prices of securities is fully incorporated in their prices. Takes a weak form (past data conveys no information), semistrong form (all publicly available information is incorporated), strong form (all information, whether public or not, is incorporated). The difference between returns on stocks equity premium (shares) and returns on risk-free assets. An agreement to buy or sell a commodity or futures contract security at a future date at a fixed price agreed now. A position in which all competitive markets in general (competitive) an economic system are simultaneously in equilibrium equilibrium. The total value of output (before gross domestic product depreciation) produced within the boundaries of a state.

Adam Smith observed that "such in reality is the absurd confidence which almost all men have in their own good fortune, that whenever there is the least probability of success, too great a share of it [investment] is apt to go to them [mining projects] of its own account." A Smith (1976), chap. 7, pt. 1. See Shiller (2000), pages 142-46 for a demonstration that only the methods of empirical research have changed. Shleifer (1999), Siegel (1998), survey market anomalies. The January effect is discussed by Siegel, page 254, the 1987 crash by Shiller (2000), pages 88-95. The equity premium paradox was first described by Mehra and Prescott (1985) and elaborated by Benartzi and Thaler (1995). See Dimson et al. (2002) for evidence on it. Haigh (1999) gives a thoughtful discussion of the structure oflotteries. Thomson (1998) p.125. The settlement with Proctor and Gamble was only one of several pieces of litigation that engulfed Bankers Trust. In 1995, its chief executive, Charles S.


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Wall Street: How It Works And for Whom by Doug Henwood

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accounting loophole / creative accounting, activist fund / activist shareholder / activist investor, affirmative action, Andrei Shleifer, asset allocation, asset-backed security, bank run, banking crisis, barriers to entry, borderless world, Bretton Woods, British Empire, capital asset pricing model, capital controls, central bank independence, computerized trading, corporate governance, corporate raider, correlation coefficient, correlation does not imply causation, credit crunch, currency manipulation / currency intervention, David Ricardo: comparative advantage, debt deflation, declining real wages, deindustrialization, dematerialisation, diversification, diversified portfolio, Donald Trump, equity premium, Eugene Fama: efficient market hypothesis, experimental subject, facts on the ground, financial deregulation, financial innovation, Financial Instability Hypothesis, floating exchange rates, full employment, George Akerlof, George Gilder, hiring and firing, Hyman Minsky, implied volatility, index arbitrage, index fund, information asymmetry, interest rate swap, Internet Archive, invisible hand, Irwin Jacobs, Isaac Newton, joint-stock company, Joseph Schumpeter, kremlinology, labor-force participation, late capitalism, law of one price, liberal capitalism, liquidationism / Banker’s doctrine / the Treasury view, London Interbank Offered Rate, Louis Bachelier, market bubble, Mexican peso crisis / tequila crisis, microcredit, minimum wage unemployment, money market fund, moral hazard, mortgage debt, mortgage tax deduction, Myron Scholes, oil shock, Paul Samuelson, payday loans, pension reform, Plutocrats, plutocrats, price mechanism, price stability, prisoner's dilemma, profit maximization, publication bias, Ralph Nader, random walk, reserve currency, Richard Thaler, risk tolerance, Robert Gordon, Robert Shiller, Robert Shiller, selection bias, shareholder value, short selling, Slavoj Žižek, South Sea Bubble, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, The Market for Lemons, The Nature of the Firm, The Predators' Ball, The Wealth of Nations by Adam Smith, transaction costs, transcontinental railway, women in the workforce, yield curve, zero-coupon bond

Shleifer, Andrei, and Lawrence H. Summers (1990). "The Noise Trader Approach to Finance," Journal of Economic Perspectives A (Spring), pp. 19-33. Shleifer, Andrei, and Robert W. Vishny (1986). "Large Shareholders and Corporate Control," Journal of Political Economy 9A, pp. 461-488. Shrikhande, Milind M. (1996). "Nonaddictive Habit Formation and the Equity Premium Puzzle," Federal Reserve Bank of Atlanta Working Paper 96-1 (February). Siegel, Jeremy J, (1992). "The Equity Premium: Stock and Bond Returns Since 1802," Financial Analysts Journal (February), pp. 28-38. Simmel, Georg (1978). The Philosophy of Money (Boston: Beacon Press). Simmons, Jacqueline (1996). "Home Prices Soar in Unexpected Places," Wall Street Journal, February 13- Simons, Katerina, and Stephen Cross (1991). "Do Capital Markets Predict Problems in Large Commercial Banks?

Over the very long term stocks greatly outperform any other asset class, but most people don't care about the long term; they want to be in today's hot sector, the day after tomorrow be damned. While stocks do outperform over the very long term, it's not really clear why; their performance can't be explained by most conventional financial models (Mehra and Prescott 1985; Siegel 1992). This is known as the equity premium puzzle in the trade. Many ingenious attempts have been made to solve the puzzle — like "nonaddictive habit formation" (Shrikhande 1996), whatever that means — but none have done so definitively. When measured against long-term economic growth — and Siegel's work covers the U.S. from 1802 through 1990, about as long-term as an anlysis can get — stock returns seem too high and bond returns too low.

When questioned, flacks from the libertarian Cato Institute — which is advised by the former Chilean cabinet minister who guided the transformation — make two points: the historical returns on stocks are higher than the implied return on Social Security, and money put into the stock market will promote real investment. As we've already seen, financial theory can't explain stock returns very well (the equity premium puzzle), and virtually no money put into the stock market goes into real investment. When confronted with these details, Cato's flacks sputter and mutter, but they have no solid answer other than to denounce the managerial skills of "government bureaucrats." Flacks also profess great faith in the public's ability to manage its retirement portfolio, but even people with advanced degrees don't really understand the basic arithmetic of interest rates, much less the complexities of modern financial markets.


pages: 364 words: 101,286

The Misbehavior of Markets by Benoit Mandelbrot

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Albert Einstein, asset allocation, Augustin-Louis Cauchy, Benoit Mandelbrot, Big bang: deregulation of the City of London, Black-Scholes formula, British Empire, Brownian motion, buy low sell high, capital asset pricing model, carbon-based life, discounted cash flows, diversification, double helix, Edward Lorenz: Chaos theory, Elliott wave, equity premium, Eugene Fama: efficient market hypothesis, Fellow of the Royal Society, full employment, Georg Cantor, Henri Poincaré, implied volatility, index fund, informal economy, invisible hand, John Meriwether, John von Neumann, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, market bubble, market microstructure, Myron Scholes, new economy, paper trading, passive investing, Paul Lévy, Paul Samuelson, Plutocrats, plutocrats, price mechanism, quantitative trading / quantitative finance, Ralph Nelson Elliott, RAND corporation, random walk, risk tolerance, Robert Shiller, Robert Shiller, short selling, statistical arbitrage, statistical model, Steve Ballmer, stochastic volatility, transfer pricing, value at risk, Vilfredo Pareto, volatility smile

Its output—the pressure or velocity of water, the average or change in price—can swing wildly, suddenly. It is hard to predict, harder to protect against, hardest of all to engineer and profit from. Conventional finance ignores this, of course. It assumes the financial system is a linear, continuous, rational machine. That kind of thinking ties conventional economists into logical knots. Consider the so-called Equity Premium Puzzle, a chestnut of the scholarly literature since its discovery two decades ago by two young economists, Rajnish Mehra and Edward C. Prescott. Why is it that stocks, according to the averages, generally reward investors so richly? The data say that, over the long stretch of the twentieth century, stocks provided a massive “premium” return over that of supposedly safer investments, such as U.S.

Just one out-of-the-average year of losing more than a third of capital—as happened with many stocks in 2002—would justifiably scare even the boldest investors away for a long while. The problem also assumes wrongly that the bell curve is a realistic yardstick for measuring the risk. As I have said often, real prices gyrate much more wildly than the Gaussian standards assume. In this light, there is no puzzle to the equity premium. Real investors know better than the economists. They instinctively realize that the market is very, very risky, riskier than the standard models say. So, to compensate them for taking that risk, they naturally demand and often get a higher return. The same reasoning—that people instinctively understand the market is very risky—helps explain why so much of the world’s wealth remains in safe cash, rather than in anything riskier.

In favor of multifractals: their parsimony, the fact that the “turbulent” behavior is not deliberately inputted but obtained as output of simplet interpolative cartoons. Multifractals should not be viewed as an “ad-hoc” structure but as the natural counterpart of two classical tools; the generating function (that is, the sequence of moments) and spectral analysis. Their parameters are intrinsic. Chapter XII Ten Heresies of Finance 230 “Consider the so-called Equity Premium Puzzle…” A good summary of their initial paper, and the difficulty it had in getting published, is provided in Mehra and Prescott 2003. 231 “The same reasoning…” For more on this, see Babeau, André and Sbano 2002. In fact, the precise asset allocation recommendations can vary from that 25-30-45 mix, depending on what the market is doing at any particular time. 232 “The ultimate fear…” See Embrechts, Klüppelberg and Mikosch 1997. 234 “Concentration is common…” See Lantsman, Major and Mangano 2002. 235 “One day when I was working…” Alexander’s “Filter” method attracted a great deal of attention–and similar methods have been devised and tried since his day.


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Phishing for Phools: The Economics of Manipulation and Deception by George A. Akerlof, Robert J. Shiller, Stanley B Resor Professor Of Economics Robert J Shiller

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Andrei Shleifer, asset-backed security, Bernie Madoff, Capital in the Twenty-First Century by Thomas Piketty, collapse of Lehman Brothers, corporate raider, Credit Default Swap, Daniel Kahneman / Amos Tversky, dark matter, David Brooks, en.wikipedia.org, endowment effect, equity premium, financial intermediation, financial thriller, fixed income, full employment, George Akerlof, greed is good, income per capita, invisible hand, John Maynard Keynes: Economic Possibilities for our Grandchildren, Kenneth Arrow, Kenneth Rogoff, late fees, loss aversion, Menlo Park, mental accounting, Milgram experiment, money market fund, moral hazard, new economy, Pareto efficiency, Paul Samuelson, payday loans, Ponzi scheme, profit motive, publication bias, Ralph Nader, randomized controlled trial, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Reagan, Silicon Valley, the new new thing, The Predators' Ball, the scientific method, The Wealth of Nations by Adam Smith, theory of mind, Thorstein Veblen, too big to fail, transaction costs, Unsafe at Any Speed, Upton Sinclair, Vanguard fund, Vilfredo Pareto, wage slave

Such big-money managers are known to scramble for returns that are higher by even a few basis points—that is, by a few hundredths of 1 percent. But not only was there a huge demand for these bonds at the prevailing interest rates, there was also, potentially, a huge supply of them. As far as the eye could see, going back to the beginning of the nineteenth century, the returns on stocks had been enormous. So large is the gap between the return on stocks and the return on bonds that this difference has earned a name: the equity premium. The equity premium was so large that, for example, a $100,000 trust fund initiated in 1925 and invested in treasuries would have been worth only $1.3 million seventy years later, in 1995; but the same trust fund invested and reinvested in stocks would have been worth more than $80 million.11 If you were so lucky as to have had a mildly rich great-grandmother who invested in a stock trust fund like this, you would not be poor.

In Corporate Takeovers: Causes and Consequences, edited by Alan J. Auerbach, pp. 33–68. Chicago: University of Chicago Press, 1988. Shleifer, Andrei, and Robert W. Vishny. “The Takeover Wave of the 1980s.” Science 249, no. 4970 (1990): 745–49. Sidel, Robin. “Credit Card Issuers Are Charging Higher.” Wall Street Journal, October 12, 2014. Siegel, Jeremy J., and Richard H. Thaler. “Anomalies: The Equity Premium Puzzle.” Journal of Economic Perspectives 11, no. 1 (Winter 1997): 191–200. Sinclair, Upton. The Jungle. Mineola, NY: Dover Thrift Editions, 2001; originally published 1906. —. Letter to the New York Times. May 6, 1906. Singh, Gurkirpal. “Recent Considerations in Nonsteroidal Anti-Inflammatory Drug Gastropathy.” American Journal of Medicine 105, no. 1, supp. 2 (July 27, 1998): 31S–38S. Skeel, David A., Jr.

Gary Smith, Standard Deviations: Flawed Assumptions, Tortured Data, and Other Ways to Lie with Statistics. (New York: Duckworth Overlook, 2014). NOTES Akerlof.indb 245 245 6/19/15 10:24 AM 9. Jesse Kornbluth, Highly Confident: The Crime and Punishment of Michael Milken (New York: William Morrow, 1992), p. 45. 10. Hickman, Corporate Bond Quality and Investor Experience, p. 10. 11. Jeremy J. Siegel and Richard H. Thaler, “Anomalies: The Equity Premium Puzzle,” Journal of Economic Perspectives 11, no. 1 (Winter 1997): 191. 12. United States Federal Deposit Insurance Corporation et al. v. Michael R. Milken et al. (1991), Southern District of New York (January 18), Amended Complaint Class Action, Civ. No. 91-0433 (MP), pp. 70–71. 13. See James B. Stewart, Den of Thieves (New York: Simon and Schuster, 1992), pp. 521–22; and Benjamin Stein, A License to Steal: The Untold Story of Michael Milken and the Conspiracy to Bilk the Nation (New York: Simon and Schuster, 1992). 14.


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Investing Demystified: How to Invest Without Speculation and Sleepless Nights by Lars Kroijer

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Andrei Shleifer, asset allocation, asset-backed security, Bernie Madoff, bitcoin, Black Swan, BRICs, Carmen Reinhart, cleantech, compound rate of return, credit crunch, diversification, diversified portfolio, equity premium, estate planning, fixed income, high net worth, implied volatility, index fund, intangible asset, invisible hand, Kenneth Rogoff, market bubble, money market fund, passive investing, pattern recognition, prediction markets, risk tolerance, risk/return, Robert Shiller, Robert Shiller, selection bias, sovereign wealth fund, too big to fail, transaction costs, Vanguard fund, yield curve, zero-coupon bond

Figure 5.7 MSCI World index since inception (dividends reinvested) Lars’s predictions So, in simple terms, on average I expect to make a 4–5% return a year above the minimal risk rate5 in a broad-based world equity portfolio. This is not to suggest that I expect this return to materialise every year, but rather that if I had to make a guess on the compounding annual rate in future it would be 4–5% (see Table 5.2). Note that while the equity premium here is compared to short-term US bonds I would expect the same premium to other minimal risk currency government bonds because the real return expectation of short-term US government bonds is roughly similar to that of other AAA/AA countries like the UK, Germany, Japan, etc. Table 5.2 Expected future returns (including returns from dividends) (%) Real1 Risk2 World equities 4.5–5.5 20.00 Minimal risk asset 0.50 Equity risk premium 4–5 1After inflation. 2See Chapter 6 for a discussion of issues with risk measures.

If I dropped my daily Starbucks visit and put the £4 daily savings into the equity markets at a 5% annual return I would have almost five times the current average national income in the UK in savings on the day I turned 70 (I am 40 now). Many of you may be uncomfortable with having important stock market expectations simply being based on something as unscientific as historical returns or my ‘guesstimate’ of that data. Perhaps so, but until someone comes up with a reliably better method of predicting stock market returns it’s the best we have and a very decent guide. Also, we know that the equity premium should be something – if there were no expected rewards from investing in the riskier equities we would simply keep our money in low-risk bonds. Another problem with simplistically predicting a stable risk premium is that we don’t change it in line with the world around us. It probably sits wrong with most investors that the expected returns in future should be the same in the relatively stable period preceding the 2008 crash as it was during the peak of panic and despair in October 2008.

Did someone who contemplated investing in the market in the calm of 2006 really expect to be rewarded with the same return as someone who stepped into the mayhem of October 2008? Someone willing to step into the market at a moment of high panic would expect to be compensated for taking that extra risk, suggesting that the risk premium is not a constant number, but in some way dependent on the risk of the market. At a time of higher expected long-term risk, equity investors will be expecting higher long-term returns. The equity premium outlined above is an expected average based on an average level of risk. In summary In the interest of making something as complicated as the world financial markets into something almost provocatively simple, Figure 5.8 outlines where we are in terms of returns after inflation. As an investor who seeks returns in excess of the minimal risk return you can add a broad portfolio of world equities.


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The Investopedia Guide to Wall Speak: The Terms You Need to Know to Talk Like Cramer, Think Like Soros, and Buy Like Buffett by Jack (edited By) Guinan

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Albert Einstein, asset allocation, asset-backed security, Brownian motion, business process, capital asset pricing model, clean water, collateralized debt obligation, computerized markets, correlation coefficient, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, discounted cash flows, diversification, diversified portfolio, dividend-yielding stocks, equity premium, fixed income, implied volatility, index fund, intangible asset, interest rate swap, inventory management, London Interbank Offered Rate, margin call, market fundamentalism, money market fund, mortgage debt, Myron Scholes, passive investing, performance metric, risk tolerance, risk-adjusted returns, risk/return, shareholder value, Sharpe ratio, short selling, statistical model, time value of money, transaction costs, yield curve, zero-coupon bond

The size of the risk premium will vary as the risk in a particular stock, or in the stock market as a whole, changes; high-risk investments are compensated with a higher premium. Also referred to as the equity premium. Investopedia explains Equity Risk Premium The risk premium is the result of the risk-return trade-off, in which investors require a higher rate of return on riskier investments. The risk-free rate in the market often is quoted as the rate on longerterm U.S. government bonds, which are considered risk-free because of the unlikelihood that the government will default on its loans. Compare that with securities that offer no or little guarantees. Remember, companies regularly experience downturns and go out of business. If the return on a stock is 15% and the risk-free rate over the same period is 7%, the equity-risk premium is 8% for this stock over that period. Related Terms: • Equity • Premium • Risk-Return Trade-Off • Gordon Growth Model • Risk 96 The Investopedia Guide to Wall Speak Euro LIBOR What Does Euro LIBOR Mean?

For example, if one knew a given investment had a 50% chance of earning a 10% return, a 25% chance of earning 20%, and a 25% chance of earning –10%, the expected return would be equal to 7.5%: Expected Return = (0.5) (0.1) + (0.25) (0.2) + (0.25) (–0.1). Although this is what one would expect the return to be, there is no guarantee that it will be the actual return. Related Terms: • Coefficient of Variation • Return on Assets • Total Return • Equity Premium • Return on Equity The Investopedia Guide to Wall Speak 99 Expense Ratio What Does Expense Ratio Mean? The amount it costs an investment company to operate a mutual fund. An expense ratio is determined through an annual calculation in which a fund’s operating expenses are divided by the average dollar value of its assets under management. Operating expenses are taken out of a fund’s assets and lower the return to a fund’s investors.


pages: 304 words: 22,886

Nudge: Improving Decisions About Health, Wealth, and Happiness by Richard H. Thaler, Cass R. Sunstein

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Al Roth, Albert Einstein, asset allocation, availability heuristic, call centre, Cass Sunstein, choice architecture, continuous integration, Daniel Kahneman / Amos Tversky, desegregation, diversification, diversified portfolio, endowment effect, equity premium, feminist movement, fixed income, framing effect, full employment, George Akerlof, index fund, invisible hand, late fees, libertarian paternalism, loss aversion, Mahatma Gandhi, Mason jar, medical malpractice, medical residency, mental accounting, meta analysis, meta-analysis, Milgram experiment, money market fund, pension reform, presumed consent, profit maximization, rent-seeking, Richard Thaler, Right to Buy, risk tolerance, Robert Shiller, Robert Shiller, Saturday Night Live, school choice, school vouchers, transaction costs, Vanguard fund, Zipcar

But if you had invested in mutual funds that held shares in the largest American companies (such as an S&P 500 index fund), your dollar would have grown into $2,658, a 10.4 percent rate of return, and if you had invested in a broad portfolio of the stocks of smaller companies, you could have earned even more. In economics jargon, in which stocks are referred to as equities, the difference in the returns between Treasury bills and equities is called the “equity premium.” This premium is considered to be compensation for the greater risk associated with investing in stocks. Whereas Treasury bills are guaranteed by the federal government, and are essentially risk free, investments in stocks are risky. Although the average rate of return has been 10 percent, there have been years when stocks have fallen by more than 30 percent, and on October 19, 1987, stock indexes fell 20 percent or more all around the world in a single day.

., 86 defined-benefit retirement plans, 105, 108 defined-contribution retirement plans, 105–6, 107, 123, 128, 129 design: controlled by choice architects, 10; details of, 3–4; human factors incorporated into, 82, 83; informed, 240; neutral, 3, 10; starting points inherent in, 10–11; user-friendly, 11 Design of Everyday Things, The (Norman), 83 Destiny Health Plan, 233 difficulty, degree of, 73–74 digital cameras, 90, 92–93 discount pricing, 36 discrimination, laws against, 251 Disulfiram (antabuse), 234–35 diversification heuristic, 123 divorce: and “above average” effect, 32, 224; and children, 225, 226; difficulty of obtaining, 219–20; economic prospects affected by, 224; law of, 224–26; mandatory waiting period for, 250–51; obtainable at will, 220 Doers, 42, 47 dog owners, social pressures on, 54 Dollar a day incentive, 234 domestic partnership agreements, 215–16, 223 “Don’t Mess with Texas,” 60, 61 eating: and conformity, 64; and food display, 1–3, 4–5, 10, 11, 165–66; and food selection, 7, 64; gender differences in, 64 Economist, 239–40 Econs: easy choices for, 77; homo economicus, 6–8; incentives for, 8; investment 285 286 INDEX Econs (continued ) decisions by, 120; and money, 101; not followers of fashion, 53; Reflective Systems used by, 22; unbiased forecasts made by, 7; use of term, 7 education, 199–206; accountability in, 200; in Boston, 203–5; in Charlotte, 202; charter schools, 200; child’s right to, 199, 206; and competition, 199– 200; complex choices in, 200–203; controlled choice in, 203–5; desegregation of, 203; incentive conflicts in, 203–5; No Child Left Behind, 85–86, 200– 201; in San Marcos, Texas, 205–6; school choice vouchers, 199–200, 203, 206; status quo bias in, 201–2; testing standards, 200; test scores, 200, 202; underperforming in, 201; in Worcester, 200–201 “efficient frontier,” 154 Einstein, Albert, 6 elimination by aspects, 95 emails, Civility Check for, 235 Emanuel, Rahm, 14 Emergency Planning and Community Right to Know Act (1986), 190 “emoticons,” 68, 69 employers: employee benefits offered by, 11–13; profit-sharing plans of, 128; and retirement plans, 105–6, 107–8, 111, 127, 128, 131 endowment effect, 83 energy, invisibility of, 194 energy conservation: and cost-disclosing thermostats, 99; and framing, 36–37; and home-building industry, 192–93; and social influences, 68–69; voluntary participation programs in, 194–96 energy efficiency, 195–96 Energy Star Office Products, 195–96 Enron Corporation, 125–26, 127 environmental issues, 158, 183–96; acid deposition program, 187–88; air pollution, 183, 184–85, 186, 188; auto emissions, 184, 186; auto fuel economy, 191– 92, 192, 193; cap-and-trade system in, 187, 197; Clean Air Act, 187; climate change, 183, 186, 191, 196; commandand-control regulation of, 184, 186, 189; energy conservation, 36–37, 68– 69, 99, 192–93, 194–96; energy efficiency, 195–96; energy use, 193–96; feedback and information, 188–93; greenhouse gas emissions, 186, 188, 196; incentives for, 185–88; international, 183, 187; Kyoto Protocol, 187; nudges proposed for, 193–96; ozone layer, 183; recycling, 66n; risk labeling, 189; and social influences, 68–69; trading systems in, 187–88, 197; and tragedy of the commons, 185; transparent costs of, 187; voluntary participation programs, 194–96 Environmental Protection Agency (EPA), 189; and auto fuel economy, 192, 192, 193; Energy Star Office Products program, 195–96; Green Lights program of, 195–96; Toxic Release Inventory of, 190 – 91 Equities (stocks), 118, 119–20 equity premium, 120 ERISA (Employee Retirement Income Security Act of 1974), 127–28, 131 error, expecting, 87–90, 130 “everything matters,” 3–4 evil nudgers, 239–41 expectations, 62 Experion Systems, 173 externalities, 184 FAFSA (free application for federal student aid), 139, 141 families, dispersion of, 104 Family and Medical Leave Act, 216 Federal Express, 208 Federal Housing Administration (FHA), 133–34 Federal Trade Commission (FTC), 250 feedback, 75, 90–91, 131, 188–93 529 plans (college savings accounts), 141 flexible spending accounts, 12 follow through, failure to, 112 Food and Drug Administration (FDA), 189 INDEX food display, 1–3, 4–5, 10, 11, 165–66 food selection, 7, 64 footnotes, uses of, 4n forced choice, 86, 109–10, 243 forcing function, 88 Ford, Harrison, 154 401(k) plans, 106, 107, 109, 126, 127, 128, 130 framing, 36–37 France, organ donations in, 179 Franklin, Benjamin, 47 freedom of choice, 5, 197, 252–53; danger of overreaching, 240; elimination of, 248–51; Just Maximize Choices, 9–11; opposition to, 241–43; and presumed consent, 177–79; and required choice, 86–87 frequency, 74–75 Friedman, Milton, 5, 199, 206 friendly discouragement, 201 fungibility, 50–523 gains and losses, 33–34 gambling, 33–34; low stakes, 74-75n; mental accounting in, 50–51; self-bans, 233; and strategy, 45–47 Gandhi, Mohandas, 6 gas tank caps, 88–89 Gateway Arch, St.


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Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets by Nassim Nicholas Taleb

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Antoine Gombaud: Chevalier de Méré, availability heuristic, backtesting, Benoit Mandelbrot, Black Swan, commoditize, complexity theory, corporate governance, corporate raider, currency peg, Daniel Kahneman / Amos Tversky, discounted cash flows, diversified portfolio, endowment effect, equity premium, fixed income, global village, hindsight bias, Kenneth Arrow, Long Term Capital Management, loss aversion, mandelbrot fractal, mental accounting, meta analysis, meta-analysis, Myron Scholes, Paul Samuelson, quantitative trading / quantitative finance, QWERTY keyboard, random walk, Richard Feynman, Richard Feynman, road to serfdom, Robert Shiller, Robert Shiller, selection bias, shareholder value, Sharpe ratio, Steven Pinker, stochastic process, survivorship bias, too big to fail, Turing test, Yogi Berra

It confirms that we are observing a rising-crashing market. See Goodman (1954). Writings by Soros: Soros (1988). Hayek: See Hayek (1945) and the prophetic Hayek (1994), first published in 1945. Popper’s personality: Magee (1997), and Hacohen (2001). Also an entertaining account in Edmonds and Eidinow (2001). CHAPTER 8 The millionaire next door: Stanley (1996). Equity premium puzzle: There is an active academic discussion of the “equity premium” puzzle, taking the “premium” here to be the outperformance of stocks in relation to bonds and looking for possible explanations. Very little consideration was given to the possibility that the premium may have been an optical illusion owing to the survivorship bias—or that the process may include the occurrence of black swans. The discussion seems to have calmed a bit after the declines in the equity markets after the events of 2000–2002.


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Valuation: Measuring and Managing the Value of Companies by Tim Koller, McKinsey, Company Inc., Marc Goedhart, David Wessels, Barbara Schwimmer, Franziska Manoury

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activist fund / activist shareholder / activist investor, air freight, barriers to entry, Basel III, BRICs, business climate, business process, capital asset pricing model, capital controls, Chuck Templeton: OpenTable, cloud computing, commoditize, compound rate of return, conceptual framework, corporate governance, corporate social responsibility, creative destruction, credit crunch, Credit Default Swap, discounted cash flows, distributed generation, diversified portfolio, energy security, equity premium, fixed income, index fund, intangible asset, iterative process, Long Term Capital Management, market bubble, market friction, meta analysis, meta-analysis, Myron Scholes, negative equity, new economy, p-value, performance metric, Ponzi scheme, price anchoring, purchasing power parity, quantitative easing, risk/return, Robert Shiller, Robert Shiller, shareholder value, six sigma, sovereign wealth fund, speech recognition, survivorship bias, technology bubble, time value of money, too big to fail, transaction costs, transfer pricing, value at risk, yield curve, zero-coupon bond

Even with the best statistical techniques, however, this number is probably too high, because the observable sample includes only countries with strong historical returns.5 Statisticians refer to this phenomenon as survivorship bias. Zvi Bodie writes, “There were 36 active stock markets in 1900, so why do we only look at two, [the UK and 3 E. Dimson, P. Marsh, and M. Staunton, “The Worldwide Equity Premium: A Smaller Puzzle,” in Hand- book of Investments: Equity Risk Premium, ed. R. Mehra (Amsterdam: Elsevier Science, 2007). 4 D. C. Indro and W. Y. Lee, “Biases in Arithmetic and Geometric Averages as Estimates of Long-Run Expected Returns and Risk Premia,” Financial Management 26, no. 4 (Winter 1997): 81–90; and M. E. Blume, “Unbiased Estimators of Long-Run Expected Rates of Return,” Journal of the American Statistical Association 69, no. 347 (September 1974): 634–638. 5 S.

Mathematically, every 1 percent decrease in the cost of equity for the S&P 500 index should increase the price-to-earnings (P/E) ratio of the index by roughly 20 to 25 percent. So a 3 percent drop in cost of equity would have increased the P/E from a typical trading range of 15 times to over 25 times. Yet in 2012, the P/E for the S&P 500 index was well within its normal trading range. 6 Z. Bodie, “Longer Time Horizon ‘Does Not Reduce Risk,”’ Financial Times, January 26, 2002. Marsh, and Staunton, “The Worldwide Equity Premium.” 8 The “yield to maturity” for U.S. government bonds is a good proxy for the expected return, since default expectations are virtually zero. The same is not true for corporate bonds, as we discuss later in this chapter. 9 After 2012, the yield on government bonds began a steady increase until dropping back below 2 percent in early 2015. 7 Dimson, ESTIMATING THE COST OF EQUITY 289 To overcome the inconsistency between interest rates on government bonds and market values of equities, we recommend using a synthetic riskfree rate.

Lewellen, “Predicting Returns with Financial Ratios,” Journal of Financial Economics 74, no. 2 (2004): 209–235. 14 J. Claus and J. Thomas, “Equity Premia as Low as Three Percent? Evidence from Analysts’ Earnings Forecasts for Domestic and International Stocks,” Journal of Finance 56, no. 5 (October 2001): 1629–1666; and W. R. Gebhardt, C. M. C. Lee, and B. Swaminathan, “Toward an Implied Cost of Capital,” Journal of Accounting Research 39, no. 1 (2001): 135–176. 15 E. F. Fama and K. R. French, “The Equity Premium” (Center for Research in Security Prices Working Paper 522, April 2001). 292 ESTIMATING THE COST OF CAPITAL Once you’ve estimated the real expected return, add an estimate of inflation that is consistent with your cash flow projections. Use the spread between the yield on inflation-protected bonds and regular government bonds to estimate the expected long-term inflation. In 2013, this spread was approximately 2.5 percent.


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The Four Pillars of Investing: Lessons for Building a Winning Portfolio by William J. Bernstein

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asset allocation, Bretton Woods, British Empire, buy low sell high, carried interest, corporate governance, cuban missile crisis, Daniel Kahneman / Amos Tversky, Dava Sobel, diversification, diversified portfolio, Edmond Halley, equity premium, estate planning, Eugene Fama: efficient market hypothesis, financial independence, financial innovation, fixed income, George Santayana, German hyperinflation, high net worth, hindsight bias, Hyman Minsky, index fund, invention of the telegraph, Isaac Newton, John Harrison: Longitude, Long Term Capital Management, loss aversion, market bubble, mental accounting, money market fund, mortgage debt, new economy, pattern recognition, Paul Samuelson, quantitative easing, railway mania, random walk, Richard Thaler, risk tolerance, risk/return, Robert Shiller, Robert Shiller, South Sea Bubble, survivorship bias, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, the rule of 72, transaction costs, Vanguard fund, yield curve, zero-sum game

Unfortunately, a visceral obsession with the here and now is of rather less use in modern society, particularly in the world of investing. In Chapter 1, after looking at the long-term superiority of stocks over fixed-income securities, you may have found yourself asking the question, “Why doesn’t everybody buy stocks?” Clearly, in the long term, bonds were actually more risky than stocks, in the sense that in every period of more than 30 years, stocks have outperformed bonds. In fact, many academicians refer to this as “The Equity Premium Puzzle”—why investors allowed stocks to remain so cheap that their returns so greatly and consistently exceeded that of other assets. The answer is that our primordial instincts, a relic of millions of years of evolution, cause us to feel more pain when we suddenly lose 30% of our liquid net worth than when we face the more damaging possibility of failing to meet our long-term financial goals.

Scribner’s, 1953. Siegel, Jeremy J., Stocks for the Long Run. McGraw-Hill, 1998. Smith, Edgar L., Stocks as Long Term Investments. Macmillan, 1924. Sobel, Dava, Longitude. Walker & Co., 1995. Strouse, Jean, Morgan: American Financier. Random House, 1999. White, Eugene N., ed., Crashes and Panics. Dow Jones Irwin, 1990. Chapter 7 Benzarti, S., and Thaler, Richard H., “Myopic Risk Aversion and the Equity Premium Puzzle.” Quarterly Journal of Economics, January 1993. Brealy, Richard A., An Introduction to Risk and Return from Common Stocks. M. I. T. Press, 1969. DeBondt, Werner F.M., and Thaler, Richard H., “Further Evidence On Investor Overreaction and Stock Market Seasonality.” Journal of Finance, July 1987. Fuller, R.J., Huberts, L.C., and Levinson, M.J., “Returns to E/P Strategies; Higgledy Piggledy Growth; Analysts Forecast Errors; and Omitted Risk Factors.”


pages: 537 words: 144,318

The Invisible Hands: Top Hedge Fund Traders on Bubbles, Crashes, and Real Money by Steven Drobny

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Albert Einstein, Asian financial crisis, asset allocation, asset-backed security, backtesting, banking crisis, Bernie Madoff, Black Swan, Bretton Woods, BRICs, British Empire, business process, capital asset pricing model, capital controls, central bank independence, collateralized debt obligation, commoditize, Commodity Super-Cycle, commodity trading advisor, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency peg, debt deflation, diversification, diversified portfolio, equity premium, family office, fiat currency, fixed income, follow your passion, full employment, George Santayana, Hyman Minsky, implied volatility, index fund, inflation targeting, interest rate swap, inventory management, invisible hand, London Interbank Offered Rate, Long Term Capital Management, market bubble, market fundamentalism, market microstructure, moral hazard, Myron Scholes, North Sea oil, open economy, peak oil, pension reform, Ponzi scheme, prediction markets, price discovery process, price stability, private sector deleveraging, profit motive, purchasing power parity, quantitative easing, random walk, reserve currency, risk tolerance, risk-adjusted returns, risk/return, savings glut, selection bias, Sharpe ratio, short selling, sovereign wealth fund, special drawing rights, statistical arbitrage, stochastic volatility, survivorship bias, The Great Moderation, Thomas Bayes, time value of money, too big to fail, transaction costs, unbiased observer, value at risk, Vanguard fund, yield curve, zero-sum game

In fact, one of the great, untold stories of the last 20 years of real money investing is the unprecedented reallocation of institutional risk into the illiquidity risk premium. Most private investments are simply equivalents of their public market counterparts wrapped up with an illiquidity risk premium. I am not aware of any plan that had an explicitly defined allocation to the illiquidity premium the way they had, for example, explicitly defined allocations to the equity premium or fixed income risk premium. Nevertheless, it was where they had chosen to allocate a great deal of their risk. However, even after taking into account deliberate allocations to illiquid assets, most plans still had more illiquidity risk than they realized. More overlooked were investments in assets that were liquid in good times but became very illiquid in periods of stress, including external managers who threw up gates, credit derivatives whereby whole tranches became toxic, and even crowded trades such as single stocks chosen according to well-known quantitative screens.

Board of Governors of the Federal Reserve System, www.federalreserve.gov, 1945-2009. Fort Washington Capital Partners Group, “Why Over-Commitment Is Required to Achieve Target Exposures to Private Equity,” April 2007. Foundation Center. “Top Funders: Top 100 U.S. Foundations by Asset Size.” FoundationCenter.org, November 19, 2009. “Foundation Trusts ‘Must Plan for Spending Cuts’.” Health Service Journal, August 11, 2009. Fornari, Fabio. “The Size of the Equity Premium.” European Central Bank (ECB), January 2002. Gilbert, Katie. “He Dare Not Speak Their Name: Just Because This Danish Pension Officer Avoids Saying ‘Hedge Funds’ Doesn’t Mean He Doesn’t Love What They Represent.” Institutional Investor’s Alpha, July-August 2009. Golden, Daniel. “Cash Me If You Can.” Portfolio.com, March 18, 2009. Governance and Accountability Institute. “California Public Employees’ Retirement System (CalPERS).”INSIGHTS-edge, November 20, 2009. www.gaiinsightsedge.com.


pages: 305 words: 69,216

A Failure of Capitalism: The Crisis of '08 and the Descent Into Depression by Richard A. Posner

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Andrei Shleifer, banking crisis, Bernie Madoff, collateralized debt obligation, collective bargaining, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, debt deflation, diversified portfolio, equity premium, financial deregulation, financial intermediation, Home mortgage interest deduction, illegal immigration, laissez-faire capitalism, Long Term Capital Management, market bubble, money market fund, moral hazard, mortgage debt, Myron Scholes, oil shock, Ponzi scheme, price stability, profit maximization, race to the bottom, reserve currency, risk tolerance, risk/return, Robert Shiller, Robert Shiller, savings glut, shareholder value, short selling, statistical model, too big to fail, transaction costs, very high income

The current economic emergency is similarly the outgrowth of the bursting of an investment bubble. The bubble started in housing but eventually engulfed the financial industry. Low interest rates, aggressive and imaginative marketing of home mortgages, auto loans, and credit cards, diminishing regulation of the banking industry, and perhaps the rise of a speculative culture —an increased appetite for risk, illustrated by a decline in the traditional equity premium (the margin by which the average return on an investment in stocks exceeds that of an investment in bonds, which are less risky than stocks)—spurred speculative lending, especially on residential real estate, which is bought mainly with debt. As in 1929, the eventual bursting of the bubble endangered the solvency of banks and other financial institutions. Residential-mortgage debt is huge ($11 trillion by the end of 2006), and many defaults were expected as a result of the bubble's collapse.


pages: 829 words: 186,976

The Signal and the Noise: Why So Many Predictions Fail-But Some Don't by Nate Silver

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airport security, availability heuristic, Bayesian statistics, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, big-box store, Black Swan, Broken windows theory, Carmen Reinhart, Claude Shannon: information theory, Climategate, Climatic Research Unit, cognitive dissonance, collapse of Lehman Brothers, collateralized debt obligation, complexity theory, computer age, correlation does not imply causation, Credit Default Swap, credit default swaps / collateralized debt obligations, cuban missile crisis, Daniel Kahneman / Amos Tversky, diversification, Donald Trump, Edmond Halley, Edward Lorenz: Chaos theory, en.wikipedia.org, equity premium, Eugene Fama: efficient market hypothesis, everywhere but in the productivity statistics, fear of failure, Fellow of the Royal Society, Freestyle chess, fudge factor, George Akerlof, haute cuisine, Henri Poincaré, high batting average, housing crisis, income per capita, index fund, Intergovernmental Panel on Climate Change (IPCC), Internet Archive, invention of the printing press, invisible hand, Isaac Newton, James Watt: steam engine, John Nash: game theory, John von Neumann, Kenneth Rogoff, knowledge economy, locking in a profit, Loma Prieta earthquake, market bubble, Mikhail Gorbachev, Moneyball by Michael Lewis explains big data, Monroe Doctrine, mortgage debt, Nate Silver, negative equity, new economy, Norbert Wiener, PageRank, pattern recognition, pets.com, Pierre-Simon Laplace, prediction markets, Productivity paradox, random walk, Richard Thaler, Robert Shiller, Robert Shiller, Rodney Brooks, Ronald Reagan, Saturday Night Live, savings glut, security theater, short selling, Skype, statistical model, Steven Pinker, The Great Moderation, The Market for Lemons, the scientific method, The Signal and the Noise by Nate Silver, The Wisdom of Crowds, Thomas Bayes, Thomas Kuhn: the structure of scientific revolutions, too big to fail, transaction costs, transfer pricing, University of East Anglia, Watson beat the top human players on Jeopardy!, wikimedia commons

.: of 1892, 334 of 1988, 67 of 2000, 11, 67, 68, 468–69 of 2008, 19, 48–49, 55, 56, 59, 60, 252, 426, 468 of 2010, 57–58, 61, 64 of 2012, 59, 65, 333, 336 electrical engineering, 173 Elements of Poker (Angelo), 325 Elias Baseball Analyst, 77 Ellsbury, Jacoby, 101 El Niño-Southern Oscillation (ENSO) cycle, 392, 393, 401, 403 Emanuel, Kerry, 384–85, 387 Emanuel, Rahm, 48 English Civil War, 4 Enlightenment, 2, 112 Enron, 356 entitlement, sense of, 326 epidemiology, 204–31 basic reproduction number in, 214–15, 215, 224, 225 extrapolation in, 212–16 self-canceling predictions in, 219–20 self-fulfilling predictions in, 217–18 SIR model in, 220–21, 221, 223, 225, 389 equity holdings, 357 equity premium puzzle, 349n ERA, 91, 95 ESPN, 294–95, 308 “Essay Toward Solving a Problem in the Doctrine of Chances,” 241 Estonia, 50–51, 52 ethnography, 228 European debt crisis, 198 European Union, 397–98 evacuations, 126–27 evolution, 292 EVTMX (Eaton Vance Dividend Builder A), 339–40 experience, 57, 312 Expert Political Judgment (Tetlock), 52 experts, 14, 52–53 definition of, 467 demand for, 202 extrapolation, 212–16 eyesight, 123, 124 FAA, 423 Fair, Ray C., 482 false negatives, 372 false positives, 245, 249–50, 251, 253 falsifiability, 14–15, 452 Fama, Eugene, 337–38, 339–40, 341, 346, 347, 353, 362, 363, 368n, 497 Fannie Mae, 33 fashion, 217 fatalism, 5 fate: American belief in control of, 10 in Julius Caesar, 4–5, 10 fat tails, 368, 496 fault lines, 162 favorite-longshot bias, 497 fear, vs. greed, 38 Federal Elections Commission, 69 Federal Open Markets Committee, 190–91 Federal Reserve, 37, 188 Federal Reserve Bank of Boston, 198 Federal Reserve Bank of New York, 465 Federal Reserve Bank of Philadelphia, 179 feedback: in climate system, 133 in economic forecasts, 188, 195 negative, 38, 39 positive, 38, 39, 368 on weather forecasting, 134–35, 386 FEMA, 141 Fenway Park, 79 Fesenko, Kyrylo, 238 Fine, Reuben, 272 First Amendment, 380 fiscal policy, 42, 186n Fischer, Bobby, 286–88, 287, 443 fish, in poker, 312, 316, 317–19 Fisher, Ronald Aylmer, 251–52, 254, 256–57, 259, 260 Fitch Ratings, 19, 24 FiveThirtyEight, 9, 48, 59, 61, 62, 62, 65, 67, 69, 314, 320, 468, 497 Intrade vs., 334, 335, 336–37 Five Tools, 95–96 Fleming, Alexander, 119 Flip That House, 32 Flip This House, 32 Floehr, Eric, 131, 132, 133–34, 474 flood prediction, 177–79, 178 floods, 145, 177–79, 178 flop, in poker, 299, 303, 303, 304, 305, 306, 310 Florida, 108 flu, 204–5 A/Victoria, 205–6, 208 bird, 209, 216, 229 H1N1, see H1N1 H3N2, 216 news about, 230 1957 outbreak of, 229 1968 outbreak of, 229 Spanish, 205, 211, 214, 224, 229 vaccine for, 206–8, 483–84 fluid dynamics, 118 football, 80n, 92–93, 185–86, 336 Ford, Gerald, 206, 208, 229 Ford, Henry, 212 forecasting: in baseball, 72–73, 76–77, 82–84, 93, 99–103; see also PECOTA; scouts in chess, 271, 289 by computer, 289 of earthquakes, see earthquake forecasting as planning and decision making under uncertainty, 5, 267 predictions vs., 5, 149 progress and, 5 updating of, 73 forecasting, global warming, 380–82 complexity in, 382 consensus in, 382–84 uncertainty in, 382 ForecastWatch.com, 132 foreshocks, 144, 154, 155–57, 476 Fort Dix, 204, 206, 208, 223–25, 229 Fort Riley, 205 fortune-telling, 5 Fourier, Joseph, 375 foxes, 53–54, 54, 55, 73 consensus process emulated by, 67 improvements in predictions by, 57, 68 as television pundits, 56 Fox News, 51n, 55, 56 France, 120 Franklin, Benjamin, 262 Freakonomics (Levitt and Dubner), 9 Freakonomics blog, 136–37, 334 FRED, 225–26 Freddie Mac, 33 free agents, 82, 90, 94, 99 free markets, 1, 128, 332, 369, 370, 451, 496–97 free will, 112 see also determinism French Wars of Religion, 4 frequentism, 252–53, 254, 259, 260 Freud, Sigmund, 53 Friedel, Frederic, 278–79, 282–83 Fritz, 278, 282n Frontline, 370n Fukushima nuclear reactor, 11, 168 Full Tilt Poker, 309 fundamental analysis, 341, 348, 354 fundamentals-based models, in elections forecasting, 68 futarchy, 201 Future Shock (Toffler), 12, 13 Galfond, Phil, 309 Galileo, 4, 254 Gallup polls, 364–65, 497 gambling, 232–61, 238 on baseball, 286 Bayesian philosophy’s esteem for, 255–56, 362 over-under line, 239–40, 257, 286 point spread, 239 Game Change, 59 Game of the Century, 286–88, 287 game theory, 284–85, 311, 419 Gates, Bill, 264 Gates, H.

* Take, for instance, the oft-cited statistic that the stock market returns 7 percent annually after dividends and inflation. This is just a historical average. Reliable stock market data only goes back 120 years or so—not all that much data if you really want to know about the long run. Statistical tests suggest that the true long-run return—what we might expect over the next 120 years—could be anywhere from 3 percent to 10 percent instead of 7 percent. The answer to what economists call the “equity premium puzzle”—why stocks have returned so much more money than bonds in a way that is disproportionate to the risks they entail—may simply be that the returns stocks achieved in the twentieth century were anomalous, and the true long-run return is not as high as 7 percent. * This is no surprise given how poor most of us—including most of us who invest for a living—are at estimating probabilities.


pages: 695 words: 194,693

Money Changes Everything: How Finance Made Civilization Possible by William N. Goetzmann

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Albert Einstein, Andrei Shleifer, asset allocation, asset-backed security, banking crisis, Benoit Mandelbrot, Black Swan, Black-Scholes formula, Bretton Woods, Brownian motion, capital asset pricing model, Cass Sunstein, collective bargaining, colonial exploitation, compound rate of return, conceptual framework, corporate governance, Credit Default Swap, David Ricardo: comparative advantage, debt deflation, delayed gratification, Detroit bankruptcy, disintermediation, diversified portfolio, double entry bookkeeping, Edmond Halley, en.wikipedia.org, equity premium, financial independence, financial innovation, financial intermediation, fixed income, frictionless, frictionless market, full employment, high net worth, income inequality, index fund, invention of the steam engine, invention of writing, invisible hand, James Watt: steam engine, joint-stock company, joint-stock limited liability company, laissez-faire capitalism, Louis Bachelier, mandelbrot fractal, market bubble, means of production, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, Myron Scholes, new economy, passive investing, Paul Lévy, Ponzi scheme, price stability, principal–agent problem, profit maximization, profit motive, quantitative trading / quantitative finance, random walk, Richard Thaler, Robert Shiller, Robert Shiller, shareholder value, short selling, South Sea Bubble, sovereign wealth fund, spice trade, stochastic process, the scientific method, The Wealth of Nations by Adam Smith, Thomas Malthus, time value of money, too big to fail, trade liberalization, trade route, transatlantic slave trade, transatlantic slave trade, tulip mania, wage slave

In the 1970s, with Edgar Lawrence Smith mostly forgotten, two young Chicago professors, Roger Ibbotson and Rex Sinquefield, decided to return to the basic question of whether stocks were a good long-term investment. They used a database from the Chicago Center for Research in Security Prices called “CRSP.” They also collected data on US government bonds not previously studied by Smith or other analysts from the 1920s and 1930s and set about measuring the equity premium—the amount by which stock returns exceeded bond returns. Their finding? Stocks outperformed short-term US debt by about 6% per year over the period 1926 to 1976. Their sample fortuitously was completely independent of Edgar Lawrence Smith’s study and included not only the Great Depression and the Second World War but also the horrendous stagflation of the early 1970s, when US share prices in real terms dropped by as much as 50%.

See also investment entropy, 284 Ephesus, electrum coins at, 98–99, 101 equestrian class of Rome, 105–6, 112; publican societies and, 122, 123, 124 equity for debt swap: of John Law’s conglomerate, 355–58; of South Sea Company, 339–42 equity investments: Genoese debt converted into, 291–92; Keynes as advocate of, 471; by Rome’s equestrian class, 106, 123; Scholastic thinkers on risk premium for, 236. See also stock markets; stocks equity markets: eighteenth-century turn away from, 380–81, 382; globalization of, 403–4; of seventeenth-century London, 326. See also stock markets equity premium, 509 equity trading partnerships, Mesopotamian, 64; of Assur, 60–61; for Dilmun trade from Ur, 53–54 Essay on a Land Bank (Law), 351–53 An Essay upon Projects (Defoe), 323–25, 326–27, 342 European Central Bank, 220 European finance, 203, 205; assignable feudal rights framework for, 215–17, 219–20; born of political weakness and fragmentation, 203, 219, 520; eighteenth-century innovations in, 398–400; key stages in, 203; for medieval milling and mining firms, 303–4; overview of innovations in, 203; resurgence after year 1000 and, 226.


pages: 354 words: 26,550

High-Frequency Trading: A Practical Guide to Algorithmic Strategies and Trading Systems by Irene Aldridge

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algorithmic trading, asset allocation, asset-backed security, automated trading system, backtesting, Black Swan, Brownian motion, business process, capital asset pricing model, centralized clearinghouse, collapse of Lehman Brothers, collateralized debt obligation, collective bargaining, computerized trading, diversification, equity premium, fault tolerance, financial intermediation, fixed income, high net worth, implied volatility, index arbitrage, information asymmetry, interest rate swap, inventory management, law of one price, Long Term Capital Management, Louis Bachelier, margin call, market friction, market microstructure, martingale, Myron Scholes, New Journalism, p-value, paper trading, performance metric, profit motive, purchasing power parity, quantitative trading / quantitative finance, random walk, Renaissance Technologies, risk tolerance, risk-adjusted returns, risk/return, Sharpe ratio, short selling, Small Order Execution System, statistical arbitrage, statistical model, stochastic process, stochastic volatility, systematic trading, trade route, transaction costs, value at risk, yield curve, zero-sum game

Lyons, Richard K., 2001. The Microstructure Approach to Exchange Rates. MIT Press. MacKinlay, A.C., 1997. “Event Studies in Economics and Finance.” Journal of Economic Literature XXXV, 13–39. Mahdavi, M., 2004. “Risk-Adjusted Return When Returns Are Not Normally Distributed: Adjusted Sharpe Ratio.” Journal of Alternative Investments 6 (Spring), 47–57. Maki, A. and T. Sonoda, 2002. “A Solution to the Equity Premium and Riskfree Rate Puzzles: An Empirical Investigation Using Japanese Data.” Applied Financial Economics 12, 601–612. Markowitz, Harry M., 1952. “Portfolio Selection,” Journal of Finance 7 (1), 77–91. Markowitz, Harry, 1959. Portfolio Selection: Efficient Diversification of Investments. New York: John Wiley & Sons. Second Edition, 1991,Cambridge, MA: Basil Blackwell. Markowitz, H.M. and P. Todd, 2000.

All About Asset Allocation, Second Edition by Richard Ferri

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activist fund / activist shareholder / activist investor, asset allocation, asset-backed security, barriers to entry, Bernie Madoff, capital controls, commoditize, commodity trading advisor, correlation coefficient, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, equity premium, estate planning, financial independence, fixed income, full employment, high net worth, Home mortgage interest deduction, implied volatility, index fund, intangible asset, Long Term Capital Management, Mason jar, money market fund, mortgage tax deduction, passive income, pattern recognition, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, selection bias, Sharpe ratio, survivorship bias, too big to fail, transaction costs, Vanguard fund, yield curve

If only there were a way to time these things! But there is not. Consequently, a long-term strategic position must be taken, with a long-term estimation of the risk premium. Given the risk of stocks and the current valuation of the market, a good prediction for the long-term equity risk premium going forward is about 3 percent annualized over long-term corporate bonds. I’ll take a conservative view on the equity premium over corporate bonds and give it a 2 percent annualized expectation. U.S. equity expectation ⫽ expected long-term corporate bonds ⫹ equity risk premium There are other risk premiums that can be applied to the expected return on a portfolio in addition to the inherent risk of the equity market. For example, small-cap value stocks have a Realistic Market Expectations FIGURE 231 11-7 Rolling 10-Year Small-Cap Value Premium FF Small-Cap Value Stock Return Less the Total Stock Market Return 20% Excess return of small cap value stocks over the stock market 10 year moving average 15% 10% 5% Long-term Average 0% 2009 2005 2001 1997 1993 1989 1985 1981 1977 1973 1969 1965 1961 1957 1953 1949 1945 1941 1937 -5% distinctive risk premium over large-cap stocks.

The Age of Turbulence: Adventures in a New World (Hardback) - Common by Alan Greenspan

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air freight, airline deregulation, Albert Einstein, asset-backed security, bank run, Berlin Wall, Bretton Woods, business process, call centre, capital controls, central bank independence, collateralized debt obligation, collective bargaining, conceptual framework, Corn Laws, corporate governance, corporate raider, correlation coefficient, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, cuban missile crisis, currency peg, Deng Xiaoping, Dissolution of the Soviet Union, Doha Development Round, double entry bookkeeping, equity premium, everywhere but in the productivity statistics, Fall of the Berlin Wall, fiat currency, financial innovation, financial intermediation, full employment, Gini coefficient, Hernando de Soto, income inequality, income per capita, invisible hand, Joseph Schumpeter, labor-force participation, labour market flexibility, laissez-faire capitalism, land reform, Long Term Capital Management, Mahatma Gandhi, manufacturing employment, market bubble, means of production, Mikhail Gorbachev, moral hazard, mortgage debt, Myron Scholes, new economy, North Sea oil, oil shock, open economy, Pearl River Delta, pets.com, Potemkin village, price mechanism, price stability, Productivity paradox, profit maximization, purchasing power parity, random walk, reserve currency, Right to Buy, risk tolerance, Ronald Reagan, shareholder value, short selling, Silicon Valley, special economic zone, the payments system, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, total factor productivity, trade liberalization, trade route, transaction costs, transcontinental railway, urban renewal, working-age population, Y2K, zero-sum game

A Federal Reserve System that will be confronted with the challenge of inflation pressures and populist politics that have been relatively quiescent in recent years If the Fed is prevented from constraining inflationary forces, we could be faced with: 4. A core inflation rate markedly above the 2.2 percent of 2006 5. A ten-year treasury note flirting with a double-digit yield sometime before 2030, compared with under 5 percent in 2006 6. Risk spreads and equity premiums significantly larger than in 2006, and 7. Therefore, yields on stocks greater than in 2006 (the result of a projected quarter century of subdued asset price increases through 2030), and, consonant with that, lower ratios of real estate capitalization 498 More ebooks visit: http://www.ccebook.cn ccebook-orginal english ebooks This file was collected by ccebook.cn form the internet, the author keeps the copyright.


pages: 1,242 words: 317,903

The Man Who Knew: The Life and Times of Alan Greenspan by Sebastian Mallaby

airline deregulation, airport security, Andrei Shleifer, anti-communist, Asian financial crisis, balance sheet recession, bank run, barriers to entry, Benoit Mandelbrot, Bretton Woods, central bank independence, centralized clearinghouse, collateralized debt obligation, conceptual framework, corporate governance, correlation does not imply causation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency peg, energy security, equity premium, fiat currency, financial deregulation, financial innovation, fixed income, Flash crash, forward guidance, full employment, Hyman Minsky, inflation targeting, information asymmetry, interest rate swap, inventory management, invisible hand, Kenneth Rogoff, Kitchen Debate, laissez-faire capitalism, Long Term Capital Management, low skilled workers, market bubble, market clearing, Martin Wolf, money market fund, moral hazard, mortgage debt, Myron Scholes, new economy, Nixon shock, Northern Rock, paper trading, paradox of thrift, Paul Samuelson, Plutocrats, plutocrats, popular capitalism, price stability, RAND corporation, rent-seeking, Robert Shiller, Robert Shiller, rolodex, Ronald Reagan, Saturday Night Live, savings glut, secular stagnation, short selling, The Great Moderation, the payments system, The Wealth of Nations by Adam Smith, too big to fail, trade liberalization, unorthodox policies, upwardly mobile, WikiLeaks, women in the workforce, Y2K, yield curve, zero-sum game

They used this short-term borrowing to buy higher-yielding longer-term debt—including, not least, securitized mortgages. In this way, credit funds known as “SIVs” and “conduits” bridged the supposed divide between the federal funds rate and longer-term market interest rates. The general scramble for yield explained why, as Roger Ferguson observed, risky bonds were not being priced appropriately.42 “The potential snapback effects are large,” Greenspan went on. “We are always better off if equity premiums are moderate to slightly high or yields are moderate to slightly high because the vulnerability to substantial changes in market psychology is then obviously less.” Exuberant markets posed a risk, in other words. “In my view we are vulnerable at this stage to fairly dramatic changes in psychology,” Greenspan said ominously. Summing up this threat of a “snapback,” Greenspan was certain where it came from.