Customer Reviews

The Equity Risk Premium: The Long-Run Future of the Stock Market

5 star:		(2)
4 star:		(3)
3 star:		(1)
2 star:		(2)
1 star:		(1)

 

 

This book combines historical perspective with current academic thinking to outline what the long-run future returns are likely to be in the American stock market. It is not a pop investment book, so be prepared to put in some effort. However, that effort is well rewarded with new insight into the workings of the market.

The surprising, and well supported, conclusion? In the years ahead stocks will perform significantly worse than they have historically when compared to the returns on bonds.

The author, Professor Bradford Cornell, gives an analytical, yet very readable, explanation and forecast of the decline of the stock market during the past couple of years. In this regard Professor Cornell makes a similar conclusion about the value of equtiies and slightly earlier than did Robert J. Shiller in his book, Irrational Exuberance. It is unfortunate that Professor Cornell and his book did not get the same attention that was accorded to Professor Shiller at the start of the stock market decline.

The thesis of the book is that the equity risk premium for stocks, which is the compensation given to equity investors for holding shares of risky common stocks, was below, perhaps much below, what was historically normal. This implied that investors came to view common stocks as being a much less risky investment than stocks had been in the past. Indeed, a quite common view of many investors before the recent fall in the stock market was the view that common stock were an appropriate vehicle for "savings" rather than just for "investment." The implication of this perception by some investors is that equities in general were likely to continue to rise in price over time and thus represented a "safe" or at least low risk vehicle for discretionary income that was not spent.

However, periods of relative low perceived risk usually do not last and are followed by periods of relatively higher perceived risk. The current period we are now in appears to be one in which the uncertainties regarding the stock market have increased and thus investors are now demanding greater compensation, that is, a higher risk premium, for bearing those uncertainties.

The reason the book does not get five stars is that the book misspecifies the constant dividend growth model equation that forms the basis for the author's explanation of the adjustment in the equity risk premium. However, this oversight should not prevent the reader from getting a great explanation of how the prices of common stocks adjust to risks from this fine book.

I read this to help me with my professional career in valuation of closely-held businesses. For those who want to understand a great deal more about the equity risk premium, it is a really helpful work.

One problem -- The index is pathetic.

The book seems to be targeted towards University researcher types more than people interested in learning about investing. If you are looking for a book that helps to explain how to value individual stocks for investment, skip this book.

There is a lot of detailed analysis of past history or stock market performance and other fundamentals. There is a comparison of dividend trends and lots of other stuff. Almost all of the book treats the entire market as a whole rather than analyzing individual stocks. I believe the conclusion of the book is that the stock market as a whole is over priced based on the extensive research performed by the author.

Recently Alan Greenspan said that the equity risk premium is the key to the future of the stock market. This, not Dow 36000, is the best book on the subject. Balanced and complete, not polemic. Every serious investor should read it.

This book was quite a disappointment and is very overpriced. If you have an academic background you will find it lacking in rigor. If you do not you may be fooled into the "illusion of understanding" but I would see that as a bad thing. Many people (myself included) read books on quantum physics or relativity for the layman just for enjoyment, and rationally seek the "illusion of understanding." This book does not rate highly in the "fun" scale. It is rather dry, and the subject matter itself is not as amusing as Schrodinger's cat or time travel. So I can only assume that non-academic readers really want to figure out how things really are, to trade their portfolios, and this book cannot satisfy that desire. This for two reasons: 1) researchers have not really solved the puzzles associated with the equity risk premium, 2) the non-technical reader cannot understand the subtleties of the subject matter. Given this, the "illusion of understanding" becomes a dangerous thing.

Save your $65 and buy some stocks for the long-run.

This book, with its many references, is a great guide to the academic literature on stock valuation. It was easy to read, very logical, and educational.

The real dillema regarding ERP is that the real ex-post ERP is irrationally different from the the ex-ante ERP required for CAPM valuations. Prof. Cornell does explore this issue well for a general audience. However, this book does not diminish my skepticism of CAPM equilibrium valuations and ex-ante ERP estimators.

According to Prof. Cornell, and much of academia, the Equity Risk Premium is represented by the difference between the returns from the S&P over time, and the returns from treasuries. This concept fails to consider the real growth in S&P earnings, which is a significant part of that difference, and "risk" is conceptually the rest, a much smaller number than suggested in this book.

Prof. Cornell offers the standard fundamental value formula on page 56 for calculating the fair market value of a stock. That formula provides "k", the return to investor from fair market value. On page 103, he plugs in the market value of AT&T International (sic) to solve for "k". He doesn't seem to realize he is substituting a theoretical "fair market value" for a "market price". That doesn't work in the algebra that I remember. He questions why it doesn't work in his example. "k" doesn't = "r" except by co-incidence. Sorry, Professor, but you are in good company. Burton Malkiel makes the same mistake in "Random Walk Down Wall St.", and Jeffrey C. Hooke in "Security Analysis on Wall St." I hate it when that happens.