Practical Applications of The Risk of Premiums

Abstract

Overview

Within the financial industry, it is generally assumed that stocks provide superior returns to bonds and bonds provide lower volatility than stocks. Asset allocators and portfolio optimizers tend to use stocks to generate returns and bonds to lower overall volatility. However, Juan Ignacio Garat at Oriens Capital in Montevideo, Uruguay, found that this premise is not always universal, and he demonstrates that it does not hold true in all markets under all conditions. In The Risk of Premiums , Garat shows that out of twenty financial markets studied, only 5 demonstrate a noteworthy equity risk premium over bonds. This is a cautionary tale of the need to question basic assumptions in the asset allocation and portfolio optimization processes.