The risk-free rate puzzle (RFRP), the inverse of the equity premium puzzle, has economists puzzled. An economic anomaly of sorts. The risk-free rate puzzle (RFRP) has economists asking, "If investors want high returns, why are they investing so much in low-payout government bonds?
Compared to bond returns, equity and stock returns are much higher. Economists would expect to see more people investing in stocks, i.e. where the money’s at. On average, you’ll make over 6% more money by putting it into stocks rather than bonds.
We should see people flocking to the stock market, which would make returns from stocks fall as more investors are sharing the wealth. As stock and equity returns drop, bonds would look more and more attractive. The gap of returns between the two would get smaller and smaller. Eventually, some investors would jump the stock market ship and onto the bond ship. Then the same thing would happen in the bond market: too many people aboard and not enough treasures for everyone. Then more people would head back to the stock market.
If this happened over time, we’d expect the rate of returns to be proportional to the risk involved for each. But with the actual numbers, economists think investors are being weirdly risk-averse. Why is everyone wasting their money on bonds when they could be earning the mega-bucks on stocks for not that much more risk?
Some economists have tried to answer this puzzle, but...nobody knows for sure.
Related or Semi-related Video
Finance: What are Systematic and Unsyste...14 Views
finance a la shmoop what are systemic and unsystematic risk systemic risks are
just endemic to the market want to invest in the stock market and compound [Plate of vegetable appear]
return your way into great wealth great but then you'll suffer the normal risk
of the system that risk specifically is this yeah best of times worst of times
but up over time the market goes up you just have to embrace the notion that [Man hugging a tree]
there is systemic risk in that in the short run you can buy an S&P 500 index
fund here then lose like a third or whatever of your money in not too many
years but if you don't panic and sell just at the wrong time here right out
the storm and keep going well then you should be just fine by the time you
arrive here so that's risk that is always in the system equities rise and [Equity in the ocean]
fall like the tides or something like that but generally they rise and if you
want to swim in this bathtub well you get used to the turbulence and have an [Girl swimming against the tide]
airsick bag handy all right that systemic risk or systemic risk
what's unsystematic risk well it's bad investors or rather bad investing it's
panicking and selling your stock just when you should be doubling down its
buying lousy companies thinking that they're cheap today but not realizing [Woman runs away from smelly girl]
that they will always be cheap because they're lousy or in a lousy industry or
run by lousy management it's buying into lousy industries that also look cheap
but are dying hello paper and pulp is yeah anyone really think that's gonna be [Paper printing]
around in 20 years all right well it's believing the dreamy hopes and prayers
of future earnings and trusting that there really will be 5 million [Traffic on the highway]
driverless cars on the road in 3 years you know good luck with that we'd love
it to be true but ain't gonna be unsystematic risk is also investing in
bonds for the long-term taking very little risk when taking little risk is
the opposite of what you should be doing when you're a young investor so yeah
systematic and unsystematic risk both exist plentifully and both can bite you [Dog bites portfolio from woman]
right in the portfolio so you got to know what both are and embrace them
for what they're worth
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