Not The Equity Risk Premium

Over at Crossing Wall Street, they’ve charted returns on long-term corporate bonds with returns on stocks. They find that the two are quite similar:

What I find interesting is that the spread between the returns of stocks and bonds really isn’t that much. I think would surprise many investors that boring bonds have held their own. Over the last 40 years, stocks have beaten bonds by a final score 10.5% to 8.4%.

The difference is theoretically due to greater risk for stocks. (Note: This is different from the usual equity risk premium which looks at stocks versus T-bills. Here I’m looking at stocks and long-term corporate bonds.) [link]

This is not too surprising, since when you’re investing in long-term corporate bonds you should expect a fairly high level of risk. How do you know that the company is going to be around to pay back your loan in 2028, for instance? I would imagine that the level of risk is appropriately determined by the markets and one can look at this as confirmation of the efficiency argument?

Also, the divergence in the ’70s and the late ’90s can be explained, respectively, by the productivity slowdown (increased uncertainty – bonds became riskier because lenders weren’t sure they’d get their money back; decreased productivity – stocks, which measure company value, went down) and the dot-com boom.

Then again, I could be simplifying too much. Take a look at the picture they have over there. It’s interesting.

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