- The most obvious measure of the risk premium on equities doesn't predict actual future returns on equities. This is a puzzle.
- What does predict returns is the dividend yield. And this points to low returns in the next five years.
How severe is the trade-off between risk and return? The question matters for us all because the higher is the risk premium on equities relative to gilts the better Is the total return we can expect on balanced portfolios of equities and gilts, and the greater is the reward for shifting out of cash or bonds and into equities.
Important as the question is, it gives us a puzzle. In theory there is a simple way of measuring this risk premium, but it doesn’t work in practice.