A THEORETICAL AND PRACTICAL PERSPECTIVE ON THE EQUITY RISK PREMIUM*

Abstract In historical perspective, equity returns have been higher than interest rates but have also varied a good deal more. However, the average excess return has been larger than what could be expected based on classical equilibrium theory: the equity risk premium (ERP) puzzle. This paper has two objectives. First, the paper presents a comprehensive overview of the vast literature developed aimed at adjusting theory and testing the robustness of the puzzle. Here we will show that the failure of theory to link asset prices to economics is mostly quantitative by nature and not qualitative (anymore). Second, beyond providing a survey of theory, we aim for a relevant practical angle as well. Our main contribution is that we spend time on why returns have been higher than investors reasonably could have expected. We present evidence that forecasts of equity returns can be enhanced by valuation models: low valuation levels (low price‐to‐earnings ratios) portend high subsequent returns. While conventional wisdom (several years ago) was to use historical returns to forecast future returns, a growing consensus now recognizes that the predictive power of valuation ratios is preferred. Finally we provide some practical implications based on this predictability. While the ERP is essentially a long‐term issue, the likelihood of a lower risk premium increases risk for many and means that short‐term volatility might not be neglected.     

那些改变和增加的条款

每一次法规的修订,都是完善法治社会的一步,《汽车产品召回监督管理条例（征求意见稿）》（以下称《征求意见稿》）就是这样一个缩影。从规定到条例,更多代表的是法律效力的上升,个中具有实质性意义的改变和增加的条款,更具有了些许＂前世今生＂的意味。     

OVERBIDDING AND HETEROGENEOUS BEHAVIOR IN CONTEST EXPERIMENTS: A COMMENT ON THE ENDOWMENT EFFECT

We revisit the meta-analysis of Sheremeta on overbidding in contest experiments and focus on the effect of endowment on overbidding. Sheremeta assumes, and finds evidence of, an increasing linear relationship between endowment and overbidding, Quantal Response Equilibrium (QRE) predicts an increasing concave relationship, while Baik and colleagues find an inverted U-shaped relationship in their analysis of a single experiment. We use the same data as in Sheremeta, but employ a different econometric model which leads to support for both QRE and the inverted U-shaped relationship. Following Baik and colleagues, we posit that the inverted-U relationship may be interpreted in terms of a wealth effect.     

MAKING UP HISTORY: A COMMENT ON PRATTEN1

Stephen Pratten's critique of mathematical formalism in the discipline of economics does not provide an adequate definition of formalism and his use of the term bears little resemblance to common mathematical usage. Furthermore, Pratten abuses the history of economics by inventing an imaginary tradition of opposition to formalism among Cambridge economists.     

COMMENT ON NAVIGATING REFORMS: LESSONS FROM INDIA, THE 2008 WINCOTT LECTURE, GIVEN BY ARUN SHOURIE

Economic growth in India has been impressive in recent years. However, development has largely by-passed agriculture and labour-intensive industry, the sectors with the most potential to drive up living standards in the long term. Despite welcome recent efforts at reform, large parts of the Indian economy continue to be hindered by poor governance and over-regulation.     

COMMENT ON THE 2011 WINCOTT LECTURE, ‘CONTROL RIGHTS (AND WRONGS)’

Over a long period leading up to the current financial crisis, small banks within a small banking system were replaced by unsafe, large banks within a huge banking system. The banks have now grown so big and so dangerous that they have the capacity to wreck economies and bring down governments.