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Why are you fixated on bonds? My argument is mostly independent of bonds, I only included them because you mentioned them originally. Your reasoning was: > Th

by adwn 10y ago

Why are you fixated on bonds? My argument is mostly independent of bonds, I only included them because you mentioned them originally. Your reasoning was: > The mechanism is much simpler: asset prices of risky assets today will fall because willing buyers demand a higher return for the risk. [...] Investors aren't happy with that, so they refuse to buy the stock until its price falls and its implied return rises. I showed that this is not a valid argument, because if the market discounts the price of a stock by x% due to higher perceived risk, then it will discount its price by x% ten years later as well (unless there was a major change in the company's fundamentals, which is another story and not relevant here), meaning that the discounting of risk did not result in higher profit (compared to the return on stocks of a company which is deemed less risky).

smallnamespace 10y ago
Bonds are the natural comparison because bonds represent relatively riskless cashflows. Bonds tell you how much you get paid in the future, stocks don't. Otherwise, how can you measure the return to risk? > then it will discount its price by x% ten years later as well That doesn't follow because you're missing a free parameter. Let's say a piece of stock ought to be worth $110 in 1 year if people weren't risk averse (based on how we think the company will do, etc.), but it'll only be worth $100 because of the risk. It can still be worth $91 today, implying a 10% return, for example. For any path of future expected equity values, regardless of what future discount you apply, there is a price today that will imply an equity risk premium. FYI, people have empirically measured the implied equity risk premium over long periods of time. The general consensus is that equity returns around 5-10% more per annum that a risk-free asset, but it varies greatly from decade to decade: https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr714.pdf https://www.newyorkfed.org/medialibrary/media/research/staff... https://en.wikipedia.org/wiki/Equity_premium_puzzle https://en.wikipedia.org/wiki/Equity_premium_puzzle
- adwn 10y ago
  Those are some good points, thank you. I'll have to think about this for some time.

by adwn 10y ago

smallnamespace 10y ago

Bonds are the natural comparison because bonds represent relatively riskless cashflows. Bonds tell you how much you get paid in the future, stocks don't. Otherwise, how can you measure the return to risk? > then it will discount its price by x% ten years later as well That doesn't follow because you're missing a free parameter. Let's say a piece of stock ought to be worth $110 in 1 year if people weren't risk averse (based on how we think the company will do, etc.), but it'll only be worth $100 because of the risk. It can still be worth $91 today, implying a 10% return, for example. For any path of future expected equity values, regardless of what future discount you apply, there is a price today that will imply an equity risk premium. FYI, people have empirically measured the implied equity risk premium over long periods of time. The general consensus is that equity returns around 5-10% more per annum that a risk-free asset, but it varies greatly from decade to decade: https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr714.pdf https://www.newyorkfed.org/medialibrary/media/research/staff... https://en.wikipedia.org/wiki/Equity_premium_puzzle https://en.wikipedia.org/wiki/Equity_premium_puzzle

adwn 10y ago
Those are some good points, thank you. I'll have to think about this for some time.