Zvi Bodie e-mails with an interesting question, related both to my article about long-run investing in the current TIME (in which he plays a starring role) and my book:
If you doubt the rationality of the stock market, then isn’t investing in stocks a crap shoot? How can you be sure that there is a positive risk premium? The historical evidence is far from conclusive. It depends on what time periods and what countries you look at. Even the experts disagree.
Then he offers an excerpt from “the latest of many academic papers on this topic,” Are Stocks Really Less Volatile in the Long Run? by Lubos Pastor and Robert F. Stambaugh (May 22, 2009):
Of the four components ……., the one making the largest contribution at the 30-year horizon reflects uncertainty about future expected returns. This component (iii) is often neglected in discussions of how return predictability affects long-horizon return variance. Such discussions typically highlight mean reversion, but mean reversion—and predictability more generally—require variance in the conditional expected return, which we denote by t . That variance makes the future values of t uncertain, especially in the more distant future periods, thereby contributing to the overall uncertainty about future returns. The greater the degree of predictability, the larger is the variance of t and thus the greater is the relative contribution of uncertainty about future expected returns to long-horizon return variance.
Then Bodie concludes:
Under such circumstances, shouldn’t a rational investor follow the TIPS + calls approach that I advocate?
