When I first learnt about investing and studied it from free online materials, I found it very strange that Equity Risk Premium (ERP) is a thing because in my mind, if the market is pricing a stock fairly, it should account for the risk in future cashflows/dividends (earnings) by lowering expectation in earnings instead of "demanding more returns" by having ERP. Academic concepts like "stock beta" make zero sense no matter how I try to rationalise it.
A few years ago, I also came across Equity Premium Puzzle (EPP) which shows equities have outperformed debt significantly (by 5% to 8%) even when considering survivorship bias. There are studies with over 100 years of data. Since survivorship bias cannot explain EPP, I concluded that perhaps humans are just not very good at pricing equities fairly relative to debt and overcompensate for the risk of equities.
Right now, it seems like every stock is expensive and I'm wondering if this is going to be the new normal. As technology gets better thus access to public information (e.g. company info, economic news, world events, etc) gets easier, and more younger people learning about investing online (since schools around the world don't teach personal finance ever), are equity prices just going to be priced higher (i.e. lower ERP) because now the equity market gets more competitive?
ERP and EPP have always been a very interesting topic to me, but it's hard to find any deep discussion on this.
Submitted September 10, 2024 at 03:56AM by DottMySaviour https://ift.tt/8oJcbVW
