EFF/KRF: It is important to distinguish between the expected equity premium, which should be positive, and the realized premium, which is the expected premium plus the unexpected premium. Investing in stocks is risky because we do not know what the unexpected premium will be.

Uncertainty about the average unexpected premium is smaller for longer investment horizons, so if we invest for many years the average unexpected premium will typically be close to zero. As a result, the premium of equities over bonds - the sum of the positive expected premium and the random unexpected premium - is likely to be positive over long investment horizons. But over any finite horizon, no matter how long, there is a positive probability that the premium will be negative. Without this long-term uncertainty, we would see simple arbitrage opportunities between stocks and bonds. Suppose, for example, we all know stocks will beat bonds over every forty year period. If stocks lose to bonds over the next 39 years, who would buy bonds in the 40^th year? In fact, in that case we could make as much money as we want in the 40^th year with no risk by simply shorting bonds and using the proceeds to invest in stocks.