One of the nicest puzzles in economics is the equity premium puzzle (pdf). This is that economic theory says that shares should out-perform bonds by less than half a percentage point a year, whilst in fact they've out-performed by 4.6 per cent a year in the US since 1900.
There have been lots of attempts to explain this. Some say its because investors are irrational and under-estimate the long-term safety of equities. Others say the US simply got lucky (pdf), and that true returns on all equities are in fact much lower than US data suggests. And others say that it's because we are creatures of habit (pdf), and so fear even small falls in their spending.
All good efforts. But now there's another theory - women don't fancy blokes who take risks. This should create a high excess return on equities, simply by increasing the penalty attached to risk-seeking behaviour. Even this guy didn't think of that one.
Shouldn't the puzzle be why don't our theories produce something like reality? The answer to the puzzle of the precession of the perihelion of Mercury was General Relativity, a new theory, not finding another unobserved planet inside Mercury's orbit.
Posted by: Robert Schwartz | April 16, 2005 at 03:01 AM
I don't remember where I read it, but I do remember reading that it was weird that we were spending so much time trying to work out why reality wasn't consistent with theory, rather than trying to devise a new theory that better explained reality.
Posted by: Richard Hancock | April 17, 2005 at 04:05 PM
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