Supply Based Explanation of the Equity Premium PuzzleA (2009)
All of the explanations for the equity premium puzzle I have seen in the literature are based on the demand side; trying to find utility functions for a representative investor and ex-ante probability distributions for returns that would explain investors demanding such high average returns for stocks relative to bonds. I suggest a supply side explanation: The long run supply curve for corporate stock may simply be extremely long and flat, and consistently about 5 ½ percentage points in return higher than the premium bonds supply curve, even at stock quantities as high as the entire national savings rate. Why? I posit that stock might simply allow a firm to create more wealth with an investment dollar than bonds because of the flexibility of stock. Firms are able to invest in high return long run projects when they raise money with stock that they sometimes cannot when money is raised from bonds, due to the short run constraints of having to make interest payments and satisfy bond covenants.
Publication DateMarch 1, 2009
Citation InformationRichard H. Serlin. "Supply Based Explanation of the Equity Premium Puzzle" A (2009)
Available at: http://works.bepress.com/richard_serlin/18/