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81st month newsletter

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  • pgreenfinch
    Hi, dear members and visitors! I m glad to send you our group s 81st month newsletter. We had interesting discussions last month about the equity risk puzzle.
    Message 1 of 17 , Feb 5, 2007
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      Hi, dear members and visitors!

      I'm glad to send you our group's 81st month newsletter.

      We had interesting discussions last month about the equity
      risk puzzle. I still didn't extract all the juice from your
      contributions, but I could improve somewhat the glossary
      article and, for more clarity, as it had overgrown, split
      it in 3 different pages:
      * risk vs uncertainty
      (http://perso.orange.fr/pgreenfinch/bfglo/bfglo.risk.htm)
      * risk attitude, aversion...
      (http://perso.orange.fr/pgreenfinch/bfglo/bfglo.riskattitude.htm)
      * risk premium / risk premia puzzle
      (http://perso.orange.fr/pgreenfinch/bfglo/bfglo.riskpremium.htm)

      1) Monthly activity

      Our membership (subscribers / unsubscribers balance) grew
      again by about 5 with 1650+ unbouncing members.
      We had 40 messages, and the total is now a bit over 7780

      Welcome to new members. And thanks to all contributors!

      Our sister group (Finance-Academy) membership grew a little
      also and has now 330 members. That forum gives an opportunity
      to discuss not only financial theory and technical evolutions
      in finance, but also the structural evolutions of that ever
      spreading and changing industry. Those evolutions affect the
      players' behaviors and thus they can have interesting
      incidences on debates in our BF group.
      http://groups.yahoo.com/group/Finance-Academy

      2) Reminder : Two poll are still running at
      http://finance.groups.yahoo.com/group/Behavioral-Finance/polls
      Thanks for your votes.

      3) Our free BF resources at your fingertips 24/7:

      * Your permanently maintained and improved BF glossary
      500+ definitions, many of them as detailed articles.
      http://perso.orange.fr/pgreenfinch/bfglo/bfglo.a.htm

      * Martin Sewell's academic treasure chest in BF topics,
      that site is a must for students and researchers:
      http://www.behaviouralfinance.net/

      * Your behavioral stockpricer:
      http://perso.orange.fr/pgreenfinch/pricer.htm

      * Our group charter
      http://finance.groups.yahoo.com/group/Behavioral-Finance/files/
      (click BF Group charter.doc)
      also available at:
      http://perso.orange.fr/pgreenfinch/befigrouppolicy.htm

      ** Remember, you need a *yahoo ID/profile* to access all
      Yahoo group's resources (polls, links and files).
      To get it, click "account info" (in the group's homepage
      or your "my groups" page) and fill in the info you deem
      appropriate

      Wishing for many quality info and debates in this new month.

      Peter
    • leif_ericssen
      ... [snip] ... I like your reworking of the the glossary entry, Peter, is there any way I can be of help? I agree that we have not squezzed all the juice from
      Message 2 of 17 , Feb 5, 2007
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        --- In Behavioral-Finance@yahoogroups.com, "pgreenfinch"
        <pgreenfinch@...> wrote:
        >
        > Hi, dear members and visitors!
        >
        > I'm glad to send you our group's 81st month newsletter.
        >
        > We had interesting discussions last month about the equity
        > risk puzzle. I still didn't extract all the juice from your
        > contributions, but I could improve somewhat the glossary
        > article and, for more clarity, as it had overgrown, split
        > it in 3 different pages:
        > * risk vs uncertainty
        > (http://perso.orange.fr/pgreenfinch/bfglo/bfglo.risk.htm)
        > * risk attitude, aversion...
        > (http://perso.orange.fr/pgreenfinch/bfglo/bfglo.riskattitude.htm)
        > * risk premium / risk premia puzzle
        > (http://perso.orange.fr/pgreenfinch/bfglo/bfglo.riskpremium.htm)
        >
        [snip]
        >
        > Wishing for many quality info and debates in this new month.
        >
        > Peter
        >
        I like your reworking of the the glossary entry, Peter, is there any
        way I can be of help?

        I agree that we have not squezzed all the juice from the equity
        premium fruit or vegatable - btw, is premium acidic? ;)

        Perhaps the most useful contribution would be to identify and
        analyse the sources or reasons for historical equity premium, leaving
        it for individuals to decide whether or when it may be reasonable.

        Jan
      • pgreenfinch
        ... any ... leaving ... Thanks, Jan. Maybe you can sketch a tentative list of the various points to consider? Or to analyse if we keep the biological chemestry
        Message 3 of 17 , Feb 6, 2007
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          --- In Behavioral-Finance@yahoogroups.com, "leif_ericssen"
          <leif_ericssen@...> wrote:
          >
          > --- In Behavioral-Finance@yahoogroups.com, "pgreenfinch"
          > <pgreenfinch@> wrote:
          > >
          > > Hi, dear members and visitors!
          > >
          > > I'm glad to send you our group's 81st month newsletter.
          > >
          > > We had interesting discussions last month about the equity
          > > risk puzzle. I still didn't extract all the juice from your
          > > contributions, but I could improve somewhat the glossary
          > > article and, for more clarity, as it had overgrown, split
          > > it in 3 different pages:
          > > * risk vs uncertainty
          > > (http://perso.orange.fr/pgreenfinch/bfglo/bfglo.risk.htm)
          > > * risk attitude, aversion...
          > > (http://perso.orange.fr/pgreenfinch/bfglo/bfglo.riskattitude.htm)
          > > * risk premium / risk premia puzzle
          > > (http://perso.orange.fr/pgreenfinch/bfglo/bfglo.riskpremium.htm)
          > >
          > [snip]
          > >
          > > Wishing for many quality info and debates in this new month.
          > >
          > > Peter
          > >
          > I like your reworking of the the glossary entry, Peter, is there
          any
          > way I can be of help?
          >
          > I agree that we have not squezzed all the juice from the equity
          > premium fruit or vegatable - btw, is premium acidic? ;)
          >
          > Perhaps the most useful contribution would be to identify and
          > analyse the sources or reasons for historical equity premium,
          leaving
          > it for individuals to decide whether or when it may be reasonable.
          >
          > Jan

          Thanks, Jan. Maybe you can sketch a tentative list of the
          various points to consider? Or to analyse if we keep the
          biological chemestry metaphor ;-)
          Peter
        • leif_ericssen
          ... (http://perso.orange.fr/pgreenfinch/bfglo/bfglo.riskattitude.htm) ... I can try! If nothing else, writing an outline will help me to get my thinking clear
          Message 4 of 17 , Feb 7, 2007
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            --- In Behavioral-Finance@yahoogroups.com, "pgreenfinch"
            <pgreenfinch@...> wrote:
            >
            > --- In Behavioral-Finance@yahoogroups.com, "leif_ericssen"
            > <leif_ericssen@> wrote:
            > >
            > > --- In Behavioral-Finance@yahoogroups.com, "pgreenfinch"
            > > <pgreenfinch@> wrote:
            > > >
            > > > Hi, dear members and visitors!
            > > >
            > > > I'm glad to send you our group's 81st month newsletter.
            > > >
            > > > We had interesting discussions last month about the equity
            > > > risk puzzle. I still didn't extract all the juice from your
            > > > contributions, but I could improve somewhat the glossary
            > > > article and, for more clarity, as it had overgrown, split
            > > > it in 3 different pages:
            > > > * risk vs uncertainty
            > > > (http://perso.orange.fr/pgreenfinch/bfglo/bfglo.risk.htm)
            > > > * risk attitude, aversion...
            > > >
            (http://perso.orange.fr/pgreenfinch/bfglo/bfglo.riskattitude.htm)
            > > > * risk premium / risk premia puzzle
            > > > (http://perso.orange.fr/pgreenfinch/bfglo/bfglo.riskpremium.htm)
            > > >
            > > [snip]
            > > >
            > > > Wishing for many quality info and debates in this new month.
            > > >
            > > > Peter
            > > >
            > > I like your reworking of the the glossary entry, Peter, is there
            > any
            > > way I can be of help?
            > >
            > > I agree that we have not squezzed all the juice from the equity
            > > premium fruit or vegatable - btw, is premium acidic? ;)
            > >
            > > Perhaps the most useful contribution would be to identify and
            > > analyse the sources or reasons for historical equity premium,
            > leaving
            > > it for individuals to decide whether or when it may be reasonable.
            > >
            > > Jan
            >
            > Thanks, Jan. Maybe you can sketch a tentative list of the
            > various points to consider? Or to analyse if we keep the
            > biological chemestry metaphor ;-)
            > Peter
            >

            I can try! If nothing else, writing an outline will help me to get
            my thinking clear about the nature of the equity premium. I'm hoping
            it will be useful for other people by presenting one view of equity
            premium that they may/may not agree with, but will spark their own
            ideas thay hopefully they will share.

            I think that a list of things (in no particular order) that influence
            the equity premium would include:

            - Issues of time frames and liquidity.

            - Sensitivity of premium estimates to assumptions about growth and
            stability. We might include reinvestment risk here too.

            - The possibility of self-liquidating high returns from premium
            narrowing. Can the equity premium be negative?

            - Proxies for risk.

            - and debt and taxes and transaction costs.

            I'll write more about each point as soon as I get the chance, but
            that's the agenda I outlined. I don't think my list is complete for
            every thing that affects equity premium. Not even all of the most
            important influences.

            Also, I'm trying to be more descriptive than anything else. I'm not
            trying to say whether the equity premium is too large or small on a
            risk adjusted basis or irrational or not. I may have my opinions,
            but any serious investors or students will think for themselves and
            form their own considered opinions.

            Jan
          • pgreenfinch
            ... (http://perso.orange.fr/pgreenfinch/bfglo/bfglo.riskpremium.htm) ... there ... reasonable. ... hoping ... influence ... for ... not ... OK, you are right
            Message 5 of 17 , Feb 7, 2007
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              --- In Behavioral-Finance@yahoogroups.com, "leif_ericssen"
              <leif_ericssen@...> wrote:
              >
              > --- In Behavioral-Finance@yahoogroups.com, "pgreenfinch"
              > <pgreenfinch@> wrote:
              > >
              > > --- In Behavioral-Finance@yahoogroups.com, "leif_ericssen"
              > > <leif_ericssen@> wrote:
              > > >
              > > > --- In Behavioral-Finance@yahoogroups.com, "pgreenfinch"
              > > > <pgreenfinch@> wrote:
              > > > >
              > > > > Hi, dear members and visitors!
              > > > >
              > > > > I'm glad to send you our group's 81st month newsletter.
              > > > >
              > > > > We had interesting discussions last month about the equity
              > > > > risk puzzle. I still didn't extract all the juice from your
              > > > > contributions, but I could improve somewhat the glossary
              > > > > article and, for more clarity, as it had overgrown, split
              > > > > it in 3 different pages:
              > > > > * risk vs uncertainty
              > > > > (http://perso.orange.fr/pgreenfinch/bfglo/bfglo.risk.htm)
              > > > > * risk attitude, aversion...
              > > > >
              > (http://perso.orange.fr/pgreenfinch/bfglo/bfglo.riskattitude.htm)
              > > > > * risk premium / risk premia puzzle
              > > > >
              (http://perso.orange.fr/pgreenfinch/bfglo/bfglo.riskpremium.htm)
              > > > >
              > > > [snip]
              > > > >
              > > > > Wishing for many quality info and debates in this new month.
              > > > >
              > > > > Peter
              > > > >
              > > > I like your reworking of the the glossary entry, Peter, is
              there
              > > any
              > > > way I can be of help?
              > > >
              > > > I agree that we have not squezzed all the juice from the equity
              > > > premium fruit or vegatable - btw, is premium acidic? ;)
              > > >
              > > > Perhaps the most useful contribution would be to identify and
              > > > analyse the sources or reasons for historical equity premium,
              > > leaving
              > > > it for individuals to decide whether or when it may be
              reasonable.
              > > >
              > > > Jan
              > >
              > > Thanks, Jan. Maybe you can sketch a tentative list of the
              > > various points to consider? Or to analyse if we keep the
              > > biological chemestry metaphor ;-)
              > > Peter
              > >
              >
              > I can try! If nothing else, writing an outline will help me to get
              > my thinking clear about the nature of the equity premium. I'm
              hoping
              > it will be useful for other people by presenting one view of equity
              > premium that they may/may not agree with, but will spark their own
              > ideas thay hopefully they will share.
              >
              > I think that a list of things (in no particular order) that
              influence
              > the equity premium would include:
              >
              > - Issues of time frames and liquidity.
              >
              > - Sensitivity of premium estimates to assumptions about growth and
              > stability. We might include reinvestment risk here too.
              >
              > - The possibility of self-liquidating high returns from premium
              > narrowing. Can the equity premium be negative?
              >
              > - Proxies for risk.
              >
              > - and debt and taxes and transaction costs.
              >
              > I'll write more about each point as soon as I get the chance, but
              > that's the agenda I outlined. I don't think my list is complete
              for
              > every thing that affects equity premium. Not even all of the most
              > important influences.
              >
              > Also, I'm trying to be more descriptive than anything else. I'm
              not
              > trying to say whether the equity premium is too large or small on a
              > risk adjusted basis or irrational or not. I may have my opinions,
              > but any serious investors or students will think for themselves and
              > form their own considered opinions.
              >
              > Jan

              OK, you are right to start with the basics. As for the
              question can the EP be negative, I think it can be, but
              for a very small time, when a stock bubble is nearing
              its end. Also some distorsion might happen in the (rare)
              cases when interest rates are too low (either nominally
              or in real terms) and people prefer any other asset
              than liquidity or bonds. I think it is what happened in
              Japan some 10-15 years ago.
              Peter
            • leif_ericssen
              ... wrote: [snip] ... OK, starting the basics with your reply! Yes, I agree 100% with you that both sentiment (bubbles and busts) and low
              Message 6 of 17 , Feb 11, 2007
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                --- In Behavioral-Finance@yahoogroups.com, "pgreenfinch"
                <pgreenfinch@...> wrote:

                [snip]
                >
                > OK, you are right to start with the basics. As for the
                > question can the EP be negative, I think it can be, but
                > for a very small time, when a stock bubble is nearing
                > its end. Also some distorsion might happen in the (rare)
                > cases when interest rates are too low (either nominally
                > or in real terms) and people prefer any other asset
                > than liquidity or bonds. I think it is what happened in
                > Japan some 10-15 years ago.
                > Peter
                >

                OK, starting the basics with your reply!

                Yes, I agree 100% with you that both sentiment (bubbles and busts)
                and low interest rates distort the equity premium and may make it
                very high or negative. I think there is an inefficiency there. I
                think it can be exploited by clever investors but I'm not sure. The
                puzzle AISI, is why a historical equity premium was so high, that it
                was/is higher than justified by risk.

                Here is the basic argument for the equity premium: `Stocks return
                more than treasury bonds because they are more risky'. (Of course,
                the premium should be adjusted in to economic growth and inflation.)


                The belief that common stocks are the best investment class always
                Because they return so much more has probably been the dominant
                perception at the top of every bull market.

                Most people who believe this look at long-term past performance and
                assume that the future will be more of the same. Few - not all - of
                them think of the risk involved and remember that a lot of the time
                was making up for large price losses.

                I think that some of the high equity returns in the 1990s came from
                the premium shrinking. And that many investors who were bidding down
                the premium didn't realise that the long term superior returns were a
                direct result of the risk premium. So there was a short time self-
                fulfilling prophecy.


                Then there's risk, or percieved risk.

                Jeremy Siegel, author of Stocks for the Long Run, has made very good
                points about the premium puzzle and risk. He argues that equities as
                a class are not much more likely to be totally worthless than T-bonds
                so the return guarantee should not be overrated (he thinks it always
                was). Furthermore, inflation is real and so is growth and common
                stocks represent ownership of assets and earnings. When you take
                that into account, Segal reasons, stocks can actually be Safer than T-
                bonds.

                But most investors measure risk in terms of average returns and
                standard deviation over a given time frame. The equity premium
                applies most strongly to long periods of 20 years or more, although
                the benefits from reduced standard deviation do start much sooner.

                Most investors have shorter horizons than 20 years. Even with a
                higher expected return in stocks, investors see higher risk than in
                bonds short-term, and longer holding periods lower the risk but at
                the cost of liquidity.

                I really believe that many/most investors are not waiting out 20+
                years but are playing for short term gains and trying to out perform
                the market.

                We can also add investors with a future liability such as pension
                plans or annuities. And people who live off of their investments
                usually don't have 20 year time frames because they are usually older
                and have expenses.

                So, I'd expect an equity premium to reflect risk for all of the
                people and institutions who can't or won't commit to very long
                holding periods, and expect an equity premium for liquidity for long-
                term holding periods.


                The inflation risk and growth of returns part of the equity premium
                is tricky. Were stock returns too high or were risk-free interest
                rates too low? Future study of the premium should include reference
                to inflation-indexed bonds.

                And there is the fact that companies borrow money and their
                shareholders have positive leverage returns, if they are successful.

                Growth assumptions are very sensitive to external events, economic
                performance, taxes and capital requirements. That's a given, I think.

                Finally, a corrolary here is the return on equity for a business.

                Obviously most people don't own businesses or invest in private
                equity or venture capital funds, but private firms are here in
                the same world as the stock market.

                So ROE and returns available from business are relevant to equity
                premium for common stocks. Even though T-bonds are easier to
                measure, business ROE adds another reference point to compare.

                Jan
              • pgreenfinch
                Yes Jan, I think I see the circularity you detected : 1) the equity premium makes equities cheap, 2) as they are cheap, their return will be higher, 3) the
                Message 7 of 17 , Feb 12, 2007
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                  Yes Jan, I think I see the circularity you detected :

                  1) the equity premium makes equities cheap,
                  2) as they are cheap, their return will be higher,
                  3) the ex-post return being higher, there is an equity
                  premium
                  4) thus the equity premium is the result of the equity
                  premium.

                  Not easy to get out of that reasoning circle, except if
                  the market breaks it (which can happen, if it tumbles).

                  Peter

                  --- In Behavioral-Finance@yahoogroups.com, "leif_ericssen"
                  <leif_ericssen@...> wrote:
                  >
                  > --- In Behavioral-Finance@yahoogroups.com, "pgreenfinch"
                  > <pgreenfinch@> wrote:
                  >
                  > [snip]
                  > >
                  > > OK, you are right to start with the basics. As for the
                  > > question can the EP be negative, I think it can be, but
                  > > for a very small time, when a stock bubble is nearing
                  > > its end. Also some distorsion might happen in the (rare)
                  > > cases when interest rates are too low (either nominally
                  > > or in real terms) and people prefer any other asset
                  > > than liquidity or bonds. I think it is what happened in
                  > > Japan some 10-15 years ago.
                  > > Peter
                  > >
                  >
                  > OK, starting the basics with your reply!
                  >
                  > Yes, I agree 100% with you that both sentiment (bubbles and busts)
                  > and low interest rates distort the equity premium and may make it
                  > very high or negative. I think there is an inefficiency there. I
                  > think it can be exploited by clever investors but I'm not sure.
                  The
                  > puzzle AISI, is why a historical equity premium was so high, that
                  it
                  > was/is higher than justified by risk.
                  >
                  > Here is the basic argument for the equity premium: `Stocks return
                  > more than treasury bonds because they are more risky'. (Of course,
                  > the premium should be adjusted in to economic growth and
                  inflation.)
                  >
                  >
                  > The belief that common stocks are the best investment class always
                  > Because they return so much more has probably been the dominant
                  > perception at the top of every bull market.
                  >
                  > Most people who believe this look at long-term past performance and
                  > assume that the future will be more of the same. Few - not all - of
                  > them think of the risk involved and remember that a lot of the time
                  > was making up for large price losses.
                  >
                  > I think that some of the high equity returns in the 1990s came from
                  > the premium shrinking. And that many investors who were bidding
                  down
                  > the premium didn't realise that the long term superior returns were
                  a
                  > direct result of the risk premium. So there was a short time self-
                  > fulfilling prophecy.
                  >
                  >
                  > Then there's risk, or percieved risk.
                  >
                  > Jeremy Siegel, author of Stocks for the Long Run, has made very
                  good
                  > points about the premium puzzle and risk. He argues that equities
                  as
                  > a class are not much more likely to be totally worthless than T-
                  bonds
                  > so the return guarantee should not be overrated (he thinks it
                  always
                  > was). Furthermore, inflation is real and so is growth and common
                  > stocks represent ownership of assets and earnings. When you take
                  > that into account, Segal reasons, stocks can actually be Safer than
                  T-
                  > bonds.
                  >
                  > But most investors measure risk in terms of average returns and
                  > standard deviation over a given time frame. The equity premium
                  > applies most strongly to long periods of 20 years or more, although
                  > the benefits from reduced standard deviation do start much sooner.
                  >
                  > Most investors have shorter horizons than 20 years. Even with a
                  > higher expected return in stocks, investors see higher risk than in
                  > bonds short-term, and longer holding periods lower the risk but at
                  > the cost of liquidity.
                  >
                  > I really believe that many/most investors are not waiting out 20+
                  > years but are playing for short term gains and trying to out
                  perform
                  > the market.
                  >
                  > We can also add investors with a future liability such as pension
                  > plans or annuities. And people who live off of their investments
                  > usually don't have 20 year time frames because they are usually
                  older
                  > and have expenses.
                  >
                  > So, I'd expect an equity premium to reflect risk for all of the
                  > people and institutions who can't or won't commit to very long
                  > holding periods, and expect an equity premium for liquidity for
                  long-
                  > term holding periods.
                  >
                  >
                  > The inflation risk and growth of returns part of the equity premium
                  > is tricky. Were stock returns too high or were risk-free interest
                  > rates too low? Future study of the premium should include
                  reference
                  > to inflation-indexed bonds.
                  >
                  > And there is the fact that companies borrow money and their
                  > shareholders have positive leverage returns, if they are
                  successful.
                  >
                  > Growth assumptions are very sensitive to external events, economic
                  > performance, taxes and capital requirements. That's a given, I
                  think.
                  >
                  > Finally, a corrolary here is the return on equity for a business.
                  >
                  > Obviously most people don't own businesses or invest in private
                  > equity or venture capital funds, but private firms are here in
                  > the same world as the stock market.
                  >
                  > So ROE and returns available from business are relevant to equity
                  > premium for common stocks. Even though T-bonds are easier to
                  > measure, business ROE adds another reference point to compare.
                  >
                  > Jan
                  >
                • Peter Greenfinch
                  Completed the circle: 1) the equity premium makes equities cheap, 2) as they are cheap, their return will be higher, 3) the ex-post return being higher, there
                  Message 8 of 17 , Feb 12, 2007
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                    Completed the circle:
                    1) the equity premium makes equities cheap,
                    2) as they are cheap, their return will be higher,
                    3) the ex-post return being higher, there is an equity
                    premium
                    4) thus equities are cheap
                    5) and also the equity premium is the result of the equity
                    premium.

                    ----- Original Message -----
                    From: "pgreenfinch" <pgreenfinch@...>
                    To: <Behavioral-Finance@yahoogroups.com>
                    Sent: Monday, February 12, 2007 10:31 AM
                    Subject: [Behavioral-Finance] Re: 81st month newsletter


                    > Yes Jan, I think I see the circularity you detected :
                    >
                    > 1) the equity premium makes equities cheap,
                    > 2) as they are cheap, their return will be higher,
                    > 3) the ex-post return being higher, there is an equity
                    > premium
                    > 4) thus the equity premium is the result of the equity
                    > premium.
                    >
                    > Not easy to get out of that reasoning circle, except if
                    > the market breaks it (which can happen, if it tumbles).
                    >
                    > Peter
                    >
                    > --- In Behavioral-Finance@yahoogroups.com, "leif_ericssen"
                    > <leif_ericssen@...> wrote:
                    >>
                    >> --- In Behavioral-Finance@yahoogroups.com, "pgreenfinch"
                    >> <pgreenfinch@> wrote:
                    >>
                    >> [snip]
                    >> >
                    >> > OK, you are right to start with the basics. As for the
                    >> > question can the EP be negative, I think it can be, but
                    >> > for a very small time, when a stock bubble is nearing
                    >> > its end. Also some distorsion might happen in the (rare)
                    >> > cases when interest rates are too low (either nominally
                    >> > or in real terms) and people prefer any other asset
                    >> > than liquidity or bonds. I think it is what happened in
                    >> > Japan some 10-15 years ago.
                    >> > Peter
                    >> >
                    >>
                    >> OK, starting the basics with your reply!
                    >>
                    >> Yes, I agree 100% with you that both sentiment (bubbles and busts)
                    >> and low interest rates distort the equity premium and may make it
                    >> very high or negative. I think there is an inefficiency there. I
                    >> think it can be exploited by clever investors but I'm not sure.
                    > The
                    >> puzzle AISI, is why a historical equity premium was so high, that
                    > it
                    >> was/is higher than justified by risk.
                    >>
                    >> Here is the basic argument for the equity premium: `Stocks return
                    >> more than treasury bonds because they are more risky'. (Of course,
                    >> the premium should be adjusted in to economic growth and
                    > inflation.)
                    >>
                    >>
                    >> The belief that common stocks are the best investment class always
                    >> Because they return so much more has probably been the dominant
                    >> perception at the top of every bull market.
                    >>
                    >> Most people who believe this look at long-term past performance and
                    >> assume that the future will be more of the same. Few - not all - of
                    >> them think of the risk involved and remember that a lot of the time
                    >> was making up for large price losses.
                    >>
                    >> I think that some of the high equity returns in the 1990s came from
                    >> the premium shrinking. And that many investors who were bidding
                    > down
                    >> the premium didn't realise that the long term superior returns were
                    > a
                    >> direct result of the risk premium. So there was a short time self-
                    >> fulfilling prophecy.
                    >>
                    >>
                    >> Then there's risk, or percieved risk.
                    >>
                    >> Jeremy Siegel, author of Stocks for the Long Run, has made very
                    > good
                    >> points about the premium puzzle and risk. He argues that equities
                    > as
                    >> a class are not much more likely to be totally worthless than T-
                    > bonds
                    >> so the return guarantee should not be overrated (he thinks it
                    > always
                    >> was). Furthermore, inflation is real and so is growth and common
                    >> stocks represent ownership of assets and earnings. When you take
                    >> that into account, Segal reasons, stocks can actually be Safer than
                    > T-
                    >> bonds.
                    >>
                    >> But most investors measure risk in terms of average returns and
                    >> standard deviation over a given time frame. The equity premium
                    >> applies most strongly to long periods of 20 years or more, although
                    >> the benefits from reduced standard deviation do start much sooner.
                    >>
                    >> Most investors have shorter horizons than 20 years. Even with a
                    >> higher expected return in stocks, investors see higher risk than in
                    >> bonds short-term, and longer holding periods lower the risk but at
                    >> the cost of liquidity.
                    >>
                    >> I really believe that many/most investors are not waiting out 20+
                    >> years but are playing for short term gains and trying to out
                    > perform
                    >> the market.
                    >>
                    >> We can also add investors with a future liability such as pension
                    >> plans or annuities. And people who live off of their investments
                    >> usually don't have 20 year time frames because they are usually
                    > older
                    >> and have expenses.
                    >>
                    >> So, I'd expect an equity premium to reflect risk for all of the
                    >> people and institutions who can't or won't commit to very long
                    >> holding periods, and expect an equity premium for liquidity for
                    > long-
                    >> term holding periods.
                    >>
                    >>
                    >> The inflation risk and growth of returns part of the equity premium
                    >> is tricky. Were stock returns too high or were risk-free interest
                    >> rates too low? Future study of the premium should include
                    > reference
                    >> to inflation-indexed bonds.
                    >>
                    >> And there is the fact that companies borrow money and their
                    >> shareholders have positive leverage returns, if they are
                    > successful.
                    >>
                    >> Growth assumptions are very sensitive to external events, economic
                    >> performance, taxes and capital requirements. That's a given, I
                    > think.
                    >>
                    >> Finally, a corrolary here is the return on equity for a business.
                    >>
                    >> Obviously most people don't own businesses or invest in private
                    >> equity or venture capital funds, but private firms are here in
                    >> the same world as the stock market.
                    >>
                    >> So ROE and returns available from business are relevant to equity
                    >> premium for common stocks. Even though T-bonds are easier to
                    >> measure, business ROE adds another reference point to compare.
                    >>
                    >> Jan
                    >>
                    >
                    >
                    >
                    >
                    > you may unsubscribe by sending an email to
                    >
                    > Behavioral-Finance-unsubscribe@yahoogroups.com
                    >
                    > Yahoo! Groups Links
                    >
                    >
                    >
                    >
                    >
                  • leif_ericssen
                    Wow, hold the phone, Peter! The circular equity premium you describe looks like just another way of saying that 1. stocks are a good bargain when they are
                    Message 9 of 17 , Feb 12, 2007
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                      Wow, hold the phone, Peter!

                      The circular equity premium you describe looks like just another way
                      of saying that

                      1. stocks are a good bargain when they are percieved to be risky and
                      most people are fearful, and

                      2. probably are no longer cheap when they have performed well for a
                      long time and many people are interested.

                      That really wasn't what I was trying to say, although I certainly
                      agree with it.

                      I was just trying to describe some of the components that go into the
                      equity premium and influence it's size or +/- . I wasn't even trying
                      to be clever or original, except for the last part about using
                      business ROE as a reference point.

                      And maybe studying equity premium can help us by indicating when
                      stocks are reasonably priced or a disaster waiting to happen, though
                      maybe that should be a Finance Academy topic.

                      Jan

                      --- In Behavioral-Finance@yahoogroups.com, "pgreenfinch"
                      <pgreenfinch@...> wrote:
                      >
                      > Yes Jan, I think I see the circularity you detected :
                      >
                      > 1) the equity premium makes equities cheap,
                      > 2) as they are cheap, their return will be higher,
                      > 3) the ex-post return being higher, there is an equity
                      > premium
                      > 4) thus the equity premium is the result of the equity
                      > premium.
                      >
                      > Not easy to get out of that reasoning circle, except if
                      > the market breaks it (which can happen, if it tumbles).
                      >
                      > Peter
                      >
                      > --- In Behavioral-Finance@yahoogroups.com, "leif_ericssen"
                      > <leif_ericssen@> wrote:
                      > >
                      > > --- In Behavioral-Finance@yahoogroups.com, "pgreenfinch"
                      > > <pgreenfinch@> wrote:
                      > >
                      > > [snip]
                      > > >
                      > > > OK, you are right to start with the basics. As for the
                      > > > question can the EP be negative, I think it can be, but
                      > > > for a very small time, when a stock bubble is nearing
                      > > > its end. Also some distorsion might happen in the (rare)
                      > > > cases when interest rates are too low (either nominally
                      > > > or in real terms) and people prefer any other asset
                      > > > than liquidity or bonds. I think it is what happened in
                      > > > Japan some 10-15 years ago.
                      > > > Peter
                      > > >
                      > >
                      > > OK, starting the basics with your reply!
                      > >
                      > > Yes, I agree 100% with you that both sentiment (bubbles and
                      busts)
                      > > and low interest rates distort the equity premium and may make it
                      > > very high or negative. I think there is an inefficiency there.
                      I
                      > > think it can be exploited by clever investors but I'm not sure.
                      > The
                      > > puzzle AISI, is why a historical equity premium was so high, that
                      > it
                      > > was/is higher than justified by risk.
                      > >
                      > > Here is the basic argument for the equity premium: `Stocks return
                      > > more than treasury bonds because they are more risky'. (Of
                      course,
                      > > the premium should be adjusted in to economic growth and
                      > inflation.)
                      > >
                      > >
                      > > The belief that common stocks are the best investment class
                      always
                      > > Because they return so much more has probably been the dominant
                      > > perception at the top of every bull market.
                      > >
                      > > Most people who believe this look at long-term past performance
                      and
                      > > assume that the future will be more of the same. Few - not all -
                      of
                      > > them think of the risk involved and remember that a lot of the
                      time
                      > > was making up for large price losses.
                      > >
                      > > I think that some of the high equity returns in the 1990s came
                      from
                      > > the premium shrinking. And that many investors who were bidding
                      > down
                      > > the premium didn't realise that the long term superior returns
                      were
                      > a
                      > > direct result of the risk premium. So there was a short time
                      self-
                      > > fulfilling prophecy.
                      > >
                      > >
                      > > Then there's risk, or percieved risk.
                      > >
                      > > Jeremy Siegel, author of Stocks for the Long Run, has made very
                      > good
                      > > points about the premium puzzle and risk. He argues that
                      equities
                      > as
                      > > a class are not much more likely to be totally worthless than T-
                      > bonds
                      > > so the return guarantee should not be overrated (he thinks it
                      > always
                      > > was). Furthermore, inflation is real and so is growth and common
                      > > stocks represent ownership of assets and earnings. When you take
                      > > that into account, Segal reasons, stocks can actually be Safer
                      than
                      > T-
                      > > bonds.
                      > >
                      > > But most investors measure risk in terms of average returns and
                      > > standard deviation over a given time frame. The equity premium
                      > > applies most strongly to long periods of 20 years or more,
                      although
                      > > the benefits from reduced standard deviation do start much
                      sooner.
                      > >
                      > > Most investors have shorter horizons than 20 years. Even with a
                      > > higher expected return in stocks, investors see higher risk than
                      in
                      > > bonds short-term, and longer holding periods lower the risk but
                      at
                      > > the cost of liquidity.
                      > >
                      > > I really believe that many/most investors are not waiting out 20+
                      > > years but are playing for short term gains and trying to out
                      > perform
                      > > the market.
                      > >
                      > > We can also add investors with a future liability such as pension
                      > > plans or annuities. And people who live off of their investments
                      > > usually don't have 20 year time frames because they are usually
                      > older
                      > > and have expenses.
                      > >
                      > > So, I'd expect an equity premium to reflect risk for all of the
                      > > people and institutions who can't or won't commit to very long
                      > > holding periods, and expect an equity premium for liquidity for
                      > long-
                      > > term holding periods.
                      > >
                      > >
                      > > The inflation risk and growth of returns part of the equity
                      premium
                      > > is tricky. Were stock returns too high or were risk-free
                      interest
                      > > rates too low? Future study of the premium should include
                      > reference
                      > > to inflation-indexed bonds.
                      > >
                      > > And there is the fact that companies borrow money and their
                      > > shareholders have positive leverage returns, if they are
                      > successful.
                      > >
                      > > Growth assumptions are very sensitive to external events,
                      economic
                      > > performance, taxes and capital requirements. That's a given, I
                      > think.
                      > >
                      > > Finally, a corrolary here is the return on equity for a
                      business.
                      > >
                      > > Obviously most people don't own businesses or invest in private
                      > > equity or venture capital funds, but private firms are here in
                      > > the same world as the stock market.
                      > >
                      > > So ROE and returns available from business are relevant to equity
                      > > premium for common stocks. Even though T-bonds are easier to
                      > > measure, business ROE adds another reference point to compare.
                      > >
                      > > Jan
                      > >
                      >
                    • leif_ericssen
                      ... An alternating feedback loop? - A high equity premium makes high returns possible but - high returns attract more and more investors who raise prices,
                      Message 10 of 17 , Feb 13, 2007
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                        --- In Behavioral-Finance@yahoogroups.com, "Peter Greenfinch"
                        <pgreenfinch@...> wrote:
                        >
                        > Completed the circle:
                        > 1) the equity premium makes equities cheap,
                        > 2) as they are cheap, their return will be higher,
                        > 3) the ex-post return being higher, there is an equity
                        > premium
                        > 4) thus equities are cheap
                        > 5) and also the equity premium is the result of the equity
                        > premium.


                        An alternating feedback loop?

                        - A high equity premium makes high returns possible but

                        - high returns attract more and more investors who raise prices,
                        bringing temporary continued high returns but

                        - lowering the premium and increasing vulnerability to negative
                        outcomes.

                        This is basically saying that the equity premium functions as a
                        margin of error or an uncertainty reserve. If true, it dosen't seem
                        to do to well as a regulator if the premium can be very small or even
                        negative.

                        Maybe a suboptimal solution of high average premium - "the puzzle" -
                        encourages risk-takers and risk-capital, who provide a means of
                        financing ventures and projects that would never be bankable..?

                        Or maybe the puzzle is just an artifact?

                        Jan
                      • pgreenfinch
                        Yes, Finance-Academy might offer some light, as to know the premium ex-ante supposes to estimate first the so-called fair value on the basis of a riskless
                        Message 11 of 17 , Feb 13, 2007
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                          Yes, Finance-Academy might offer some light, as to know
                          the premium "ex-ante" supposes to estimate first the
                          so-called "fair value" on the basis of a riskless return
                          rate.
                          A tricky thing to do as this value calculation depends
                          on profit expectations, thus entails some guesswork.
                          But whatever the method to define the fair value in
                          absolute, we might reason instead in relative terms.
                          It might be said that if market prices jump up 20%
                          without important news that change the fundamentals,
                          the equity premium decreased proportionnally.
                          The problem with such an indirect / alternative approach
                          is that it doesn't tell what the real value is, and thus
                          what is the real premium. It gives some hints about the
                          possibility of a Shrödinger cat, but doesn't tell if it
                          is alive or not, and not even what is its weight.
                          Hello to your cats ;-)
                          Peter

                          --- In Behavioral-Finance@yahoogroups.com, "leif_ericssen"
                          <leif_ericssen@...> wrote:
                          >
                          > Wow, hold the phone, Peter!
                          >
                          > The circular equity premium you describe looks like just another
                          way
                          > of saying that
                          >
                          > 1. stocks are a good bargain when they are percieved to be risky
                          and
                          > most people are fearful, and
                          >
                          > 2. probably are no longer cheap when they have performed well for a
                          > long time and many people are interested.
                          >
                          > That really wasn't what I was trying to say, although I certainly
                          > agree with it.
                          >
                          > I was just trying to describe some of the components that go into
                          the
                          > equity premium and influence it's size or +/- . I wasn't even
                          trying
                          > to be clever or original, except for the last part about using
                          > business ROE as a reference point.
                          >
                          > And maybe studying equity premium can help us by indicating when
                          > stocks are reasonably priced or a disaster waiting to happen,
                          though
                          > maybe that should be a Finance Academy topic.
                          >
                          > Jan
                        • leif_ericssen
                          My cats may resemble that remark! ;) I think you put your finger on it with the tricky value calculation. Whether there is an equity premium or whether the
                          Message 12 of 17 , Feb 13, 2007
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                            My cats may resemble that remark! ;)

                            I think you put your finger on it with the tricky value calculation.

                            Whether there is an equity premium or whether the size of it is
                            justified or not pretty much requires the same analysis and research
                            of investing anyway.

                            Is there any value in an implied equity premium? Comparing T-bonds
                            to dividends and deriving a projected earnings growth rate?

                            Jan
                            *Moving this thread to Finance-Academy@yahoogroups.com

                            --- In Behavioral-Finance@yahoogroups.com, "pgreenfinch"
                            <pgreenfinch@...> wrote:
                            >
                            > Yes, Finance-Academy might offer some light, as to know
                            > the premium "ex-ante" supposes to estimate first the
                            > so-called "fair value" on the basis of a riskless return
                            > rate.
                            > A tricky thing to do as this value calculation depends
                            > on profit expectations, thus entails some guesswork.
                            > But whatever the method to define the fair value in
                            > absolute, we might reason instead in relative terms.
                            > It might be said that if market prices jump up 20%
                            > without important news that change the fundamentals,
                            > the equity premium decreased proportionnally.
                            > The problem with such an indirect / alternative approach
                            > is that it doesn't tell what the real value is, and thus
                            > what is the real premium. It gives some hints about the
                            > possibility of a Shrödinger cat, but doesn't tell if it
                            > is alive or not, and not even what is its weight.
                            > Hello to your cats ;-)
                            > Peter
                            >
                            > --- In Behavioral-Finance@yahoogroups.com, "leif_ericssen"
                            > <leif_ericssen@> wrote:
                            > >
                            > > Wow, hold the phone, Peter!
                            > >
                            > > The circular equity premium you describe looks like just another
                            > way
                            > > of saying that
                            > >
                            > > 1. stocks are a good bargain when they are percieved to be risky
                            > and
                            > > most people are fearful, and
                            > >
                            > > 2. probably are no longer cheap when they have performed well for
                            a
                            > > long time and many people are interested.
                            > >
                            > > That really wasn't what I was trying to say, although I certainly
                            > > agree with it.
                            > >
                            > > I was just trying to describe some of the components that go into
                            > the
                            > > equity premium and influence it's size or +/- . I wasn't even
                            > trying
                            > > to be clever or original, except for the last part about using
                            > > business ROE as a reference point.
                            > >
                            > > And maybe studying equity premium can help us by indicating when
                            > > stocks are reasonably priced or a disaster waiting to happen,
                            > though
                            > > maybe that should be a Finance Academy topic.
                            > >
                            > > Jan
                            >
                          • Michael Clemens
                            Jan and Peter, After stepping off of your merry-go-round discussion about the equity risk premium, it is quite clear that when the ex post risk premium is
                            Message 13 of 17 , Feb 14, 2007
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                              Jan and Peter,
                               
                              After stepping off of your merry-go-round discussion about the equity risk premium, it is quite clear that when the ex post risk premium is high, the ex ante risk premium is low, and vice versa.
                               
                              However, that should not be the full picture as earnings expectations must be taken into account. Recall from the present value formula that P = D/(R-g), where "R" is cost of equity and "g" is expected dividend growth. P and D are as usual Price and Dividends. Substituting D for bxE where "b" is pay-out ratio and "E" is earnings, "g" becomes expected earnings growth. Looking only at the denominator, we then get "R-g" or "Rf + Rp - g", where Rf is the risk free rate and Rp is the equity risk premium. It is now clear that since dividends and earnings expectations are rather persistent, most of the time-variation in P must stem from time variation in the components of the denominator, i.e. Rf, Rp and g (cf. also Robert Shiller's early research on excess volatility). In bull-markets, ex ante Rp is usually low (low risk aversion) but expected growth usually high, leading to a low value of the denominator and hence a high value of P. In bear markets, ex ante Rp is usually high (high risk aversion) and expected growth usually low, leading to low values of P.
                               
                              I guess the point I am trying to make is that the (ex ante) risk premium cannot be seen in isolation. 
                               
                              \\
                               
                              Michael Clemens
                               
                               
                               



                              Alt i én. Få Yahoo! Mail med adressekartotek, kalender og notesblok.
                            • pgreenfinch
                              Certainly, Michael, a low EP could be due either to a low aversion to risk or to a high expectation of growth. A subjective thing on both accounts. Which
                              Message 14 of 17 , Feb 15, 2007
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                                Certainly, Michael, a low EP could be due either to a
                                low aversion to risk or to a high expectation of growth.
                                A subjective thing on both accounts.

                                Which entails the problem of "fair value", a notion that
                                might easily become subjective. A striking example was
                                the valuation paradigm invented by the gurus of the "new
                                economy". Dotcoms businesses with no clear chance of making
                                profits were valued according to the number of subscribers
                                or visitors to their site. This criteria was in fact more
                                or less proportional to their commercial and technical
                                costs, thus more an indicator of the size of the losses
                                to expect than the size of the expected profits.

                                Peter

                                --- In Behavioral-Finance@yahoogroups.com, Michael Clemens
                                <michael.clemens@...> wrote:
                                >
                                > Jan and Peter,
                                >
                                > After stepping off of your merry-go-round discussion about the
                                equity risk premium, it is quite clear that when the ex post risk
                                premium is high, the ex ante risk premium is low, and vice versa.
                                >
                                > However, that should not be the full picture as earnings
                                expectations must be taken into account. Recall from the present
                                value formula that P = D/(R-g), where "R" is cost of equity and "g"
                                is expected dividend growth. P and D are as usual Price and
                                Dividends. Substituting D for bxE where "b" is pay-out ratio and "E"
                                is earnings, "g" becomes expected earnings growth. Looking only at
                                the denominator, we then get "R-g" or "Rf + Rp - g", where Rf is the
                                risk free rate and Rp is the equity risk premium. It is now clear
                                that since dividends and earnings expectations are rather persistent,
                                most of the time-variation in P must stem from time variation in the
                                components of the denominator, i.e. Rf, Rp and g (cf. also Robert
                                Shiller's early research on excess volatility). In bull-markets, ex
                                ante Rp is usually low (low risk aversion) but expected growth
                                usually high, leading to a low value of the denominator and hence a
                                high value of P. In bear markets, ex ante Rp is usually high
                                > (high risk aversion) and expected growth usually low, leading to
                                low values of P.
                                >
                                > I guess the point I am trying to make is that the (ex ante) risk
                                premium cannot be seen in isolation.
                                >
                                > \\
                                >
                                > Michael Clemens
                                >
                                >
                                >
                                >
                                >
                                > ---------------------------------
                                >
                                > Alt i én. Få Yahoo! Mail med adressekartotek, kalender og notesblok.
                                >
                              • leif_ericssen
                                Hi Michael, Peter.. Michael, you are right about the importance of growth expectations. I thought I had said that earlier, but looking back, I don t think I
                                Message 15 of 17 , Feb 16, 2007
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                                  Hi Michael, Peter..

                                  Michael, you are right about the importance of growth expectations.
                                  I thought I had said that earlier, but looking back, I don't think I
                                  made that clear. If I'm going to write about things that influence
                                  the EP, it needs to be much more than a few paragraphs.

                                  But yes, assumptions about growth rates is a major factor, as well as
                                  expected capital requirements which may or may not be matched by
                                  depreciation.


                                  Peter, re fair value and dotcoms, I know a lot of people were
                                  skeptikal of new economy valuation and talking head gurus. I believe
                                  that there was a large game of greater fool going on then.

                                  I should say that valuation by number of hits on a site, etc, does
                                  make sense with a new venture that aims to gain mind share then
                                  market share then profitability. The problem is that it dosen't work
                                  when there are too many ventures competing that way, and/or the
                                  people running the venture don't know how to get from one stage to
                                  the next, or worst, if they don't really care about becoming
                                  profitable.

                                  Personally, I think mineral exploration penny stocks and biotech
                                  stocks that sell on hope are fun to watch. They are a living
                                  laboratory of the greater fool and the lottery ticket effects. I
                                  don't know if they have a wider relevance though.

                                  Jan

                                  --- In Behavioral-Finance@yahoogroups.com, "pgreenfinch"
                                  <pgreenfinch@...> wrote:
                                  >
                                  > Certainly, Michael, a low EP could be due either to a
                                  > low aversion to risk or to a high expectation of growth.
                                  > A subjective thing on both accounts.
                                  >
                                  > Which entails the problem of "fair value", a notion that
                                  > might easily become subjective. A striking example was
                                  > the valuation paradigm invented by the gurus of the "new
                                  > economy". Dotcoms businesses with no clear chance of making
                                  > profits were valued according to the number of subscribers
                                  > or visitors to their site. This criteria was in fact more
                                  > or less proportional to their commercial and technical
                                  > costs, thus more an indicator of the size of the losses
                                  > to expect than the size of the expected profits.
                                  >
                                  > Peter
                                  >
                                  > --- In Behavioral-Finance@yahoogroups.com, Michael Clemens
                                  > <michael.clemens@> wrote:
                                  > >
                                  > > Jan and Peter,
                                  > >
                                  > > After stepping off of your merry-go-round discussion about the
                                  > equity risk premium, it is quite clear that when the ex post risk
                                  > premium is high, the ex ante risk premium is low, and vice versa.
                                  > >
                                  > > However, that should not be the full picture as earnings
                                  > expectations must be taken into account. Recall from the present
                                  > value formula that P = D/(R-g), where "R" is cost of equity and "g"
                                  > is expected dividend growth. P and D are as usual Price and
                                  > Dividends. Substituting D for bxE where "b" is pay-out ratio
                                  and "E"
                                  > is earnings, "g" becomes expected earnings growth. Looking only at
                                  > the denominator, we then get "R-g" or "Rf + Rp - g", where Rf is
                                  the
                                  > risk free rate and Rp is the equity risk premium. It is now clear
                                  > that since dividends and earnings expectations are rather
                                  persistent,
                                  > most of the time-variation in P must stem from time variation in
                                  the
                                  > components of the denominator, i.e. Rf, Rp and g (cf. also Robert
                                  > Shiller's early research on excess volatility). In bull-markets, ex
                                  > ante Rp is usually low (low risk aversion) but expected growth
                                  > usually high, leading to a low value of the denominator and hence a
                                  > high value of P. In bear markets, ex ante Rp is usually high
                                  > > (high risk aversion) and expected growth usually low, leading to
                                  > low values of P.
                                  > >
                                  > > I guess the point I am trying to make is that the (ex ante)
                                  risk
                                  > premium cannot be seen in isolation.
                                  > >
                                  > > \\
                                  > >
                                  > > Michael Clemens
                                  > >
                                  > >
                                  > >
                                  > >
                                  > >
                                  > > ---------------------------------
                                  > >
                                  > > Alt i én. Få Yahoo! Mail med adressekartotek, kalender og
                                  notesblok.
                                  > >
                                  >
                                • Michael Clemens
                                  Jan and Peter, On the dot.com and indeed on many emergent industries bio-tech etc.), which investors from time to time gets all too exited about, I believe
                                  Message 16 of 17 , Feb 16, 2007
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                                    Jan and Peter,
                                     
                                    On the dot.com and indeed on many emergent industries bio-tech etc.), which investors from time to time gets all too exited about, I believe that thinking in terms of real options may help. For example, the many fibre optic start-ups would of course not all succeed, i.e. they were mutually exclusive real options. The same may be said of the many comepting drug developmens within cancer and other areas of dieseases. The problem is investors failed to recognize the low probablity of success given the vast amount of competing enterprises (many of which even the most insightful analysts did not know about).
                                     
                                    //
                                     
                                    Michael Clemens



                                    Alt i én. Få Yahoo! Mail med adressekartotek, kalender og notesblok.
                                  • leif_ericssen
                                    I like thinking in terms of real options but I m very careful when applying ROT to speculative concept stocks (dot coms, biotechs, mining/oil exploration
                                    Message 17 of 17 , Feb 24, 2007
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                                      I like thinking in terms of real options but I'm very careful when
                                      applying ROT to speculative 'concept' stocks (dot coms, biotechs,
                                      mining/oil exploration stocks) because there is a moral hazard.

                                      You have to be careful of new ventures that go public vs. financed
                                      privately in venture capital. The people behind the venture decided
                                      to go public and try to sell shares to many small investors who are
                                      less sophisticated and less informed than venture capitalists would
                                      be.

                                      The promotion in any IPO is costly and the underwriters expect to be
                                      well rewarded for their cost and efforts, paid from the investors
                                      they sold the shares to. This is of course highest for small
                                      speculative stocks.

                                      You can see the potential trouble here.


                                      But I have to say that in mining and biotech, legitimate ventures do
                                      go public early for development capital. They were financed first by
                                      private investors and venture capital and have long lead times to
                                      production. As long as the share buyers understand that they are
                                      risky, it's fair.

                                      Then of course there is the issue you point out of public excitement
                                      and overconfidence. Bull markets/bubbles and overvaluation.

                                      All things considered, a greater fool approach may be rational. So
                                      may be avoidance of concept stocks, but that's not as fun :)

                                      Jan


                                      --- In Behavioral-Finance@yahoogroups.com, Michael Clemens
                                      <michael.clemens@...> wrote:
                                      >
                                      > Jan and Peter,
                                      >
                                      > On the dot.com and indeed on many emergent industries bio-tech
                                      etc.), which investors from time to time gets all too exited about, I
                                      believe that thinking in terms of real options may help. For example,
                                      the many fibre optic start-ups would of course not all succeed, i.e.
                                      they were mutually exclusive real options. The same may be said of
                                      the many comepting drug developmens within cancer and other areas of
                                      dieseases. The problem is investors failed to recognize the low
                                      probablity of success given the vast amount of competing enterprises
                                      (many of which even the most insightful analysts did not know about).
                                      >
                                      > //
                                      >
                                      > Michael Clemens
                                      >
                                      >
                                      > ---------------------------------
                                      >
                                      > Alt i én. Få Yahoo! Mail med adressekartotek, kalender og notesblok.
                                      >
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