- Equities pay a high rate of return
- Bonds pay a lower rate of return
- If there is sufficient explanation in the current literature to resolve these two differences, it at least does not explain the magnitude of the difference.
- Equities command a higher rate of return, something like 7%
- Bonds command a lower rate of return, something like 1%
- 6% seems impossibly high to compensate for the increased level of risk between the “minimum-risk asset” and the “efficient bundle.”
- Bonds – why the heck are people so willing to delay consumption for such a lousy bond return?
- 1) Loss Adversion
- 2) Loss concentrated / segmentation – poor people who aren’t able to afford stock markets push down the bond prices below what they would normally be, this increases the differential.
- 3) Habit Formation – people prefer a steady stream of consumption
- 4) Fat Tail ; peso-problem; disaster; (people have idiosyncratic expectations, when an disaster happens they begin to believe that it is actually more likely to happen again);
- 5) Vanishing It simply isn’t there anymore -- currently the problem is smaller than it historically was.
- 6) Survivor bias