Author : Peter L. Swan
Publisher :
ISBN 13 :
Total Pages : 52 pages
Book Rating : 4.:/5 (129 download)
Book Synopsis Does 'Illiquidity' Rather than 'Risk Aversion' Explain the Equity Premium Puzzle? by : Peter L. Swan
Download or read book Does 'Illiquidity' Rather than 'Risk Aversion' Explain the Equity Premium Puzzle? written by Peter L. Swan and published by . This book was released on 2008 with total page 52 pages. Available in PDF, EPUB and Kindle. Book excerpt: Yes. I aim to establish empirically that the quot;equity premiumquot; puzzle, with its 6% excess return per annum over Treasury bills for the last 100 years on the NYSE, can be explained once the value of endogenous stock market trading is incorporated into investor preferences. Within my framework, investors enjoy trading. According to my model, the quot;investor surplusquot; from trading liquid Treasury bills relative to illiquid equity is exactly compensated for by the expected equity premium. Observed transaction cost and liquidity differentials between equity and bills are consistent with the premium. Extensive tests are carried out on Australian and US NYSE data for 1955-98. The puzzle concerning the volatility of the stochastic discount factor also appears to be explained by trading behavior, which is of comparable volatility. Reasonably accurate estimates of transactions costs are extracted just from daily dividend yields and turnover. Transaction costs would need to be 400% higher to explain the premium by the quot;amortized spreadquot;, together with exogenous trading and habit formation. An ability to create unlimited wealth, implicit in some existing models, no longer applies. Additionally, the model explains the further 15-20% pa discount on illiquid quot;letterquot; stock.