stocks vs bonds
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Stocks have historically had much higher returns than bonds. Can these excess returns be justified by the higher risk attached to stocks, or are there alternative explanations?
The following is an abbreviated history of studies and models that articulate the logic of stock returns; included are both support for and alternatives to the equity risk premium.
Edgar Lawrence Smith’s 1924 book Common Stocks as Long Term Investments […] was immediately cited by Yale’s Irving Fisher as an argument for investing in a diversified portfolio of equities over bonds.5 Fisher theorized that the trend towards investment in diversified portfolios of common stock had actually changed the equity premium in the 1920’s.
Studies of various writers, especially Edgar Smith and Kenneth Van Strum have shown that in the long run stocks yield more than bonds. Economists have pointed out that the safety of bonds is largely illusory since every bondholder runs the risk of a fall in the purchasing power of money and this risk does not attach to the same degree to common stock, while the risks that do attach to them may be reduced, or insured against, by diversification…
It is in this way that investment trusts and investment council tend to diminish the risk to the common stock investor. This new movement has created a new demand for such stocks and raised their prices, at the same time it has tended to decrease the demand for, and to lower the price of, bonds.
(http://www.econ.ucsb.edu/conferences/equity05/papers/Goetzmann.pdf - Page 6)
By the end of the 1930’s, economists had developed a clear conception of the equity risk premium, a means to measure rates of return on investments, and had collected historical data extending back through American financial history for several decades.
(http://www.econ.ucsb.edu/conferences/equity05/papers/Goetzmann.pdf - Page 7)
Markowitz and
___________________________________________________________
Stocks have historically had much higher returns than bonds. Can these excess returns be justified by the higher risk attached to stocks, or are there alternative explanations?
The following is an abbreviated history of studies and models that articulate the logic of stock returns; included are both support for and alternatives to the equity risk premium.
Edgar Lawrence Smith’s 1924 book Common Stocks as Long Term Investments […] was immediately cited by Yale’s Irving Fisher as an argument for investing in a diversified portfolio of equities over bonds.5 Fisher theorized that the trend towards investment in diversified portfolios of common stock had actually changed the equity premium in the 1920’s.
Studies of various writers, especially Edgar Smith and Kenneth Van Strum have shown that in the long run stocks yield more than bonds. Economists have pointed out that the safety of bonds is largely illusory since every bondholder runs the risk of a fall in the purchasing power of money and this risk does not attach to the same degree to common stock, while the risks that do attach to them may be reduced, or insured against, by diversification…
It is in this way that investment trusts and investment council tend to diminish the risk to the common stock investor. This new movement has created a new demand for such stocks and raised their prices, at the same time it has tended to decrease the demand for, and to lower the price of, bonds.
(http://www.econ.ucsb.edu/conferences/equity05/papers/Goetzmann.pdf - Page 6)
By the end of the 1930’s, economists had developed a clear conception of the equity risk premium, a means to measure rates of return on investments, and had collected historical data extending back through American financial history for several decades.
(http://www.econ.ucsb.edu/conferences/equity05/papers/Goetzmann.pdf - Page 7)
Markowitz and
Bibliography: Campbell, John Y., and John Ammer. “What moves the stock and bond markets? A variance decomposition for long-term asset returns.” Journal of Finance 48(1) 1993: 3-37 http://dash.harvard.edu/bitstream/handle/1/3382857/campbell_whatmoves.pdf?sequence=2 Chen, Peng. “Will Bonds Outperform Stocks over the Long Run? Not Likely.” Research Foundation of CFA Institute, Vol. 2011, No. 4. Retrieved 11 March 2014. http://www.cfapubs.org/doi/pdf/10.2470/rf.v2011.n4.4