On p. 18 of the Monday, March 7 Financial Times in an article entitled, "Time to rethink as bonds' golden age comes to an end" Tony Jackson refers to a curiously obscure recent finding in the most recent Credit Suisse yearbook. I shall simply quote from the article, starting with the second sentence of paragraph 8 (I have not been able to track down this part of the Credit Suisse report):
"...there is good evidence that investors do not in fact require better odds on riskier securities, but the reverse. The source is that same Credit Suisse yearbook produced by three London Business School academics who are themselves firm believers in the ERP [Equity Risk Premium] hypothesis.
In the long run, it seems total returns from high-yielding stocks have been higher than on low-yielding or non-yielding ones. That has been true for almost all the 21 countries covered in the study. And high-yielders have also been less risky, on conventional measures such as volatility and beta. How are we to explain this?
According to other work cited in the study, it is not that investors are bad at picking high-growth stocks. In fact, they are rather good at it; but they pay far more than the growth is worth. This matches another finding, that returns from high-growth economies - such as emerging markets - are in the long run no better than the low growth ones."
Jackson goes on to note accurately that this finding violates the rational market (or efficient market) version of the ERP, an apparent anomaly like such things as the basic equity premium puzzle or the home equity premium puzzle, none of which have been satisfactorily explained by standard economic theory, although various behavioral theories appear to do so.
I do not have an explanation for this apparently newly discovered puzzle, although regular readers here will not be all that surprised that the financial markets appear to exhibit yet further failures of the standard efficiency models. In any case, I have googled it and found no label for this phenomenon. So, in parallel with the so-called equity risk premium puzzle (that people get higher returns from investing in stocks over bonds than justified by their risk), I neologistically dub this here as the "HIGH-YIELD EQUITY RISK PREMIUM PUZZLE," that stocks with high yields (dividend per price) give higher returns than explainable by their relatively low risk. Do with this information as you see fit, :-).
Survivor bias. Stocks with high yields either cut their dividend, rise significantly in price, or fall precipitously (and cut their dividend).
ReplyDeleteThose that don't do the first or the third abide.
Ken, Maybe, but this does not explain the outcome. That would be consistent with them being riskier, but apparently they are not.
ReplyDeleteBTW, I would like to change the title and label here to HIGH-YIELD EQUITY RISK PREMIUM PUZZLE, but I am on spring break in a hotel where the computer is not allowing me to access the blogspot account to do anything since I posted this. If there is somebody out there able to fix this in my message (hack, cough), I would greatly appreciate it, please, if this could be fixed, given that I am apparently not able to do it and will not be home for several days to come.
I got it fixed.
ReplyDeleteIs it plausible to blame this on moral hazard? High leverage results in situations where losses are bounded but profits can be almost limitless. The market is dominated by people betting on other people's money, sharing the profits by not the losses. This results in a perfectly rational bias towards more risky investments.
ReplyDeleteFurthermore, people are clearly prepared to pay for gambling schemes with obviously negative expected value. Just look at the popularity of lotteries. The chance of a big win seems to have a value of its own.
Are you talking about the value premium? That's been studied plenty. There's even a message board that debates it non-stop, diehards.org
ReplyDelete