Events

Professor David Solomon
Professor of Finance
Giuriceo Family Faculty Fellow
Carroll School of Management
Boston College

The starting point of nearly every asset pricing model is that investors understand that stocks outperform bonds due to their risk characteristics. We show that this was not a well understood concept until recently. Early 20th century articles often categorically rejected equities as being “speculations” that were not even an investment, or viewed stocks versus bonds as primarily being about inflation. The idea of risk as standard deviation of single period returns was pioneered by Markowitz (1952), and not popular until the 1960s. Before this, “risk” meant the chances of losing money in the long run, consistent with applying metaphors from bond defaults, and a prevailing focus on long-run cumulative performance rather than single-period performance. This conception of risk means that higher mean returns make an asset safer, not riskier, and leads to inconsistent evaluations of the same assets at different horizons (both of which we document examples of). The idea of risk as coming from correlation with consumption was absent until Lucas (1978). The necessary ideas about equity risk in Mehra and Prescott (1985)’s equity premium puzzle were almost totally absent until shortly before the article itself.