Implications
The magnitude of the equity premium has implications for resource allocation, social welfare, and economic policy. Grant and Quiggin (2005) derive the following implications of the existence of a large equity premium:
- Macroeconomic variability associated with recessions is expensive.
- Risk to corporate profits robs the stock market of most of its value.
- Corporate executives are under irresistible pressure to make short-sighted decisions.
- Policies—disinflation, costly reform that promises long-term gains at the expense of short-term pain, are much less attractive if their benefits are risky.
- Social insurance programs might well benefit from investing their resources in risky portfolios in order to mobilize additional risk-bearing capacity.
- There is a strong case for public investment in long-term projects and corporations, and for policies to reduce the cost of risky capital.
- Transaction taxes could be either for good or for ill.
Read more about this topic: Equity Premium Puzzle
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