I'm just spitballing here, just throwing it out there...
From FT Alphaville:
Understanding risk in a system of systems
David Beckworth, economist, disagrees with Larry Summers’ secular stagnation theory because he reckons it overlooks the fact risk premiums are falling. Once this phenomenon is recognised, he claims, there is no long decline in real interest rates.One of the more interesting corollaries of a declining trend in ERP is an increasing probability that 'safe assets' will outperform equities.
Beckworth puts the decline of the risk premium down to improved economic management and policy over the last 20 to 30 years. Essentially, central bank intervention in markets has been much more effective, leading to a smoothing out effect of the boom and bust business cycle, and an overall improvement in price stability.
Yet contrast that with BoE chief economist Andy Haldane’s new theory of risk in complex systems. As Haldane recounted in a speech at the end of March, central bankers — if they are to continue to be effective — need to understand the economy is no longer just a system, but rather a “system of systems”. This new nature of the economy, he suggests, is something brought to light by the 2008 crisis.
Haldane further suggests this is a structure with an entirely different risk distribution.
As Haldane notes:
For other complex systems, physical, natural, biological and social systems, this statistical distribution is known to be highly non-normal (Newman (2005)). Indeed, many of these systems are found to be Power-law distributed, with much fatter tails than would be expected from a normal distribution. To what extent are these statistical properties evident in macro-economic and financial timeseries data? Chart 14 looks at the statistical distribution of GDP growth, credit growth, equity prices and rice prices, using a long time-series covering several hundreds of year. These densities have been transformed such that, if the underlying distribution is normal, the dots trace a straight line. Any deviation at the extremities is evidence of a fat-tailed distribution.It is clear from Chart 14 that all four series exhibit a significant degree of fat-tailedness, considerably more so than a normal distribution. This is consistent with economic and financial systems, locally and globally, exhibiting complex system of systems properties. For example, a four-standard deviation event – a true catastrophe – would under a normal distribution be expected to occur roughly every 15,000 years. Under the estimated distributions for economic and financial systems, such an event would occur every 10 to 15 years.This is an important observation with regards to Beckworth’s risk premium theory because it may explain why markets would be wrong to overlook risk premiums. Boom and bust cycles, in terms of risk, are something of an irrelevance. In this new system of systems structure, the type of risk that matters most is system-destroying risk that threatens the entire interwoven web of systems....MUCH MORE
We've visited and revisited the topic of the Equity Risk Premium over the years because, as NYU/Stern's professor Aswath Damodaran puts it, 'it is the "number" that drives everything we do.'
Previously on the Risk Premium Channel:
Equity Risk Premium: "How much should people get paid for investing in the stockmarket?"
What Risk Premium Is “Normal”?
Equity Risk Premium: "Why the market’s rate of return—and your nest egg—may never recover"
A Really Smart Guy On Stocks, Bonds and Expected Returns
"The Real Role of Dividends in Building Wealth" (Clearing Up Muddled Thinking about Dividends)
The Equity Risk Premium: "Using Garbage to Measure Consumption"
Equity Risk Premium: "Why the market’s rate of return—and your nest egg—may never recover"
Expected Future Returns and More on Expected Future Returns
Knowledge@Wharton on Investor Sentiment and Equity Pricing
"What Does Consumer Confidence Imply For The Equity Risk Premium?"
We have an awful lot of posts on the equity risk premium, the quickest way to find them is a Google search of Climateer Investing:
site:climateerinvest.blogspot.com equity risk premium
