"There’s one aspect of MMT that I have some sympathy for: the notion that what we spend money on is far more important than how we finance it." — Cliff Asness
Does the equity risk premium (ERP) vary depending on the term structure? Does reversion to the mean dictate that it will decrease the longer the time horizon?
The capital asset pricing model (CAPM) is a marvel of economic scholarship. The problem is that it doesn’t always work in practice. So, we fixed it.
"If we thought of the equity premium as a fear premium," Rob Arnott says, "a lot of the so-called anomalies that we’ve talked about would not be anomalies at all."
For years, researchers have used historical returns as proxies for estimating equity risk premium. This approach is problematic, however, because the resulting estimates don't vary from one year to the next, even though equity market returns can be wildly divergent from year to year. Katsunari Yamaguchi, CFA, has developed a new method for estimating equity premiums.
“I’ve always been fascinated by and somewhat skeptical of the connection between economic growth and security returns,” William J. Bernstein says. “When you look at the broad sweep of history, it seems that both the equity risk premium and the risk-free rate have been decreasing over the past couple of centuries.”
When I was asked, “What do you believe but can’t prove in investing?” the Donald Rumsfeld quote about knowns, known unknowns, and unknown unknowns came to mind. Where in that context do unprovable beliefs fit? My first thought is that they’re known unknowns. If we have an unprovable belief, then we have a strong opinion that could be wrong, which would seem to place us squarely in the known unknowns.