March 08, 2004
Brad DeLong Says the S-Word
Robert Waldmann notes that I used the anomalously-large equity return premium as a springboard from which to say the S-word a long time ago: fifteen... no, it was eighteen years ago:
robert's random thoughts: More on the $2.4 trillion sure thing.
Brad notes that John Quiggen says the S-word.
Actually Brad et al. said the S-word a while ago [fifteen--no, it was eighteen years ago that I wrote those paragraphs] in discussing [the possible desirability of large-scale] open-market operations in the stock market (in J. Bradford De Long, Andrei Shleifer, Lawrence H. Summers, and Robert J. Waldmann (1989) "The Size and Incidence of the Losses From Noise Trading," Journal of Finance vol. 44 pp. 681-96 (July 1989)).
Now one problem with the S[ocial ]S[ecurity ]T[rust ]F[und] making a killing investing in stocks is that massive purchases would drive up prices, eliminating the puzzling equity premium--that is, driving the expected equity return premium down to a reasonable level for a representative agent or a deep-pockets long-lived agent like the S[ocial ]S[ecurity ]T[rust ]F[und]. In particular, jumps in stock prices when the plan is unsecretly discussed, proposed, and passed by congress would give windfall capital gains to investors. Uncertainty about the plan's prospects would add risk.
I think there should be a simple way to deal with this. bundle the plan to buy a lot of stock with a plan to penalize stock relative to bonds. This way the combined policy would have (roughly) no effect on stock prices. So we would need a way to penalize stock relative to bonds. How about double taxation of dividends ?
Works for me.
Ah, that was a long time ago. Back before submission to search engines had led me to delete the space that used to be in the middle of my last name...
Robert also becomes the latest to misspell John Quiggin's name...
Posted by DeLong at March 8, 2004 08:43 AM
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Thanks for looking out for correct spelling! Note that, in line with the standard position that an author's name is the one they used at the time of writing, I've kept the space in yours below.
As you'd expect, Simon Grant and I haven't neglected the implications of your excellent work on this topic. We have a working paper Noise Trader Risk and the Political Economy of Privatization (PDF file) on this very point. The abstract isThe ‘noise trader’ model of De Long et al. provides a plausible account of the determination of the equity premium. Extension of the model to allow for privatization of publicly-owned assets yields insights into the positive political economy of privatization and into the normative question of how policies should be evaluated in the presence of mistaken beliefs.
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Hi all,
I'm pretty enthusiast these days to get a grasp of the EP Puzzle. Ludvigson et al (2004) linked the recent behavior of equity risk premium to decreasing macroeconomic risk. They furher formulated a rational reqime swiching model with some 25% R2 with some 25 risk aversion, which seems to me avoid the Mehra's (2003) criticism in its forms. Am I totally wrong and should I get some sleep, or does their approach provide something worth opposing? Or is there some better forum for this kinds of questions?
See: http://www.econ.nyu.edu/user/ludvigsons/rgs.pdf
Thank you for guidance
Jamieon
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It's never right to say always, and always wrong to say never.
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