Equity premium puzzle
What is the equity premium puzzle?
It's the phenomenon that returns on stocks over the last century have been far higher than returns on government bonds. For the past century, the equity premium (equity returns minus bond returns) has been around 6% on average - an unexpectedly large percentage that has long puzzled financial academics.
Where have you heard about the equity premium puzzle?
The equity premium puzzle has been the subject of much debate and analysis - you might have heard about it in the business comment pages of leading newspapers.
What you need to know about the equity premium puzzle.
Standard theory suggests that stockholders should receive perhaps a 1% greater return from stocks than from bonds, to compensate for the bigger risks of equity investing, rather than the 6% average equity premium.
Since the equity premium puzzle was first brought to public attention in 1985, various possible reasons have been suggested for the discrepancy. Among them are: statistical error in the equity premium finding; survivorship bias helping to cause biased results; and the difference in volatility risk between equities and bonds.
