Chapter 09 App - Chapter 9 9A-1 The Historical Market Risk...

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Chapter 9 Risk and Return 9A-1 www.mhhe.com/rwj The Historical Market Risk Premium: The Very Long Run The data in Chapter 9 indicate that the returns on common stock have historically been much higher than the returns on short-term government securities. This phenomenon has bothered economists: It is difficult to justify why large numbers of rational investors pur- chase the lower-yielding bills and bonds. In 1985, Mehra and Prescott published a very influential paper that showed that the historical returns for common stocks are far too high when compared to the rates of return on short-term government securities. 1 They pointed out that the difference in returns (fre- quently called the equity premium ) implies a very high degree of risk aversion on the part of investors. Since the publication of the Mehra and Prescott research, financial economists have tried to explain the so-called equity risk premium puzzle. The high historical equity
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