Risk-Free Rate Puzzle - RFRP

The risk-free rate puzzle (RFRP), the inverse of the equity premium puzzle, has economists puzzled. An economic anomaly of sorts. The risk-free rate puzzle (RFRP) has economists asking, "If investors want high returns, why are they investing so much in low-payout government bonds?

Compared to bond returns, equity and stock returns are much higher. Economists would expect to see more people investing in stocks, i.e. where the money’s at. On average, you’ll make over 6% more money by putting it into stocks rather than bonds.

We should see people flocking to the stock market, which would make returns from stocks fall as more investors are sharing the wealth. As stock and equity returns drop, bonds would look more and more attractive. The gap of returns between the two would get smaller and smaller. Eventually, some investors would jump the stock market ship and onto the bond ship. Then the same thing would happen in the bond market: too many people aboard and not enough treasures for everyone. Then more people would head back to the stock market.

If this happened over time, we’d expect the rate of returns to be proportional to the risk involved for each. But with the actual numbers, economists think investors are being weirdly risk-averse. Why is everyone wasting their money on bonds when they could be earning the mega-bucks on stocks for not that much more risk?

Some economists have tried to answer this puzzle, but...nobody knows for sure.