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The equity premium

The equity premium is the difference between the return on a stock and the return on a bond. Typically, it’s positive—meaning stock returns are higher—although it can be negative when the stock market goes through some rough times. Over the long run, it’s definitively positive because bonds are senior to stocks in any liquidation: Bonds carry less risk and, therefore, less yield. Measuring the equity premium is tricky, though. To do it right, you must compare stocks and bonds from firms of similar quality and aggregate over many firms to smooth out anecdotal evidence and small-sample errors. Using broad indexes may also be distorting, as the firm composition may not be comparable between stock and bond indexes.

In the graph above, FRED shows one of the many examples of how you can measure the equity premium with available data, using here the very broad Wilshire 5000 index for stocks and the BofA Merrill Lynch BBB index for bonds. (BBB is a category that may be somewhat representative: not very safe but not very risky, either.) You can experiment on FRED with many other combinations. Again, you’ll find the result is positive most of the time, reflecting the simple investment advice that if saving for the long-run warrants a diversified portfolio of stocks.

How this graph was created: Search for “Wilshire 5000” and choose the total market index. Change units to “Percent Change from Year Ago.” In the “Edit Line” tab, add the second series by search for “BBB effective yield.” Customize the data by applying the formula a-b. Finally, change the frequency to monthly to make the graph less noisy.

Suggested by Christian Zimmermann.

View on FRED, series used in this post: BAMLC0A4CBBBEY, WILL5000IND

To what degree do we have degrees?

Bachelor’s degrees grow more common every year. The Census Bureau estimates, as of 2015, that 32.5% of the U.S. population 25 years or older have at least a bachelor’s degree. Yet, the GeoFRED map shows that the percentages of the vast majority of counties are lower than the national average: Almost 90% of counties are at 29.5% or less.

Looking at the regions with the highest and lowest percentages can give us some important insights. The southern U.S. claims 9 of the bottom 20 counties, which goes up to 16 of 20 if we include Kentucky and Texas. Loving County, Texas, has the lowest percentage: With a population of 112, it has only 3.7% with at least a bachelor’s degree. The top 20 counties are spread throughout the country, 7 of which are from the state of Virginia: Falls Church City and Arlington County, respectively, have 72.8% and 71.2% with at least a bachelor’s degree. This above-average cluster around Washington D.C. is home to many Fortune 500 companies and multiple federal government agencies, including the Department of Defense’s main base of operation, the Pentagon.

How the graph was created: In GeoFRED, select “Tools” and expand the “Choose Data” section. Under “Region Type” select “County,” and under “Data” search for and choose “Bachelor degree or higher.” The map defaults to the most-recent data available. Expand the “Edit Legend” section, change the number of classes to 6, and manually set the interval values.

Suggested by Joshua Berry

Consols: The never-ending bonds

FRED just added an exciting new dataset from the Bank of England: Three Centuries of Macroeconomic Data in the United Kingdom. It provides, among many others, a series on the yields of consols. These are bonds without a maturity date. Pardon? Well, that means there’s no scheduled date for final redemption, until the government decides to pay it back, and coupon payments are made until that time. Consols were first introduced in 1751 at 3.5% and have been in circulation ever since, although interest rates have varied. In 2015, the British government decided to redeem all consols in circulation.

A consol is like a stock, in that it last forever…or until the debtor decides to buy it back. However, consols have a fixed interest rate, while stocks have varying dividends. Consols are also considered to be bonds and thus have seniority over stocks in cases of bankruptcy. Another unconventional debt instrument that comes close to consols is the 100-year mortgage introduced in Japan in the 1980s to try to make homes more affordable.

How this graph was created: Search for “consol” and you should find the series among the first results.

Suggested by Christian Zimmermann.

View on FRED, series used in this post: YCLTUK


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