Investing in Financial Markets: the Empirical Evidence Flashcards
What happens when we have total returns?
all returns are automatically reinvested in the assets
Why isn’t it so good to use nominal returns instead of real returns?
Because nominal returns reflect the impact of inflation, so numbers tend to be higher, although it doesn’t affect the bonds and bills
How has inflation evolved?
Inflation has a lot more relevance today, we can even consider it relatively recent. Since now the creation of money isn’t constricted by the existence of gold, it can pretty much be created as we please, if the GDP doesn’t go with this growth, we’ll have inflation
How has been the historical evolution of stocks, bonds and bills comparatively through the past years?
stocks have outperformed evey other asset presented, and their returns have been relatively stable; in the long run, they present a lower level of risk than bonds -> stocks seem to present a mean reversion (may be unstable in the short run but stable in the long run), while bonds and bills seem to present mean aversion (their volatility is higher than expected in the long run)
How can inflation impact stocks and bonds?
when we have very large inflation, stock prices increase automaticaly and treasure bonds, since it’s a fixed income, don’t compensate investors, specially if the maturity is longer; treasurie bonds, since they have a shorter maturity (up to a year) don’t suffer so much the impact
How does the holding period relates to risk from bonds and stocks and bills?
The higher the difference between extreme returns (best and worst) the higher the risk, and we can see that the longer the holding periods are, the shorter is this difference. It’s also possible to see that at a certain point, stocks seem to be less riskier than bonds, so equities become the safest long-term investment for the preservation of purchasing power
Since stocks seem to be a better alternative in the long run, why is it so hard for investors to stay there?
One of the primary reasons is because over 1 to 2 year periods, stocks tend to outperform bonds only about 3 out of every 5 years
-Investors are short sighted and very sensitive to what happens in the short run
What is the different between bear and bull markets?
A bear market is a market that tends to decrease and a bull market is a market that tends to increase.
How can be the returns even if investors enter a market at aparently the worst time (like a bear market)?
Losses can be very significant, but the returns generated by stocks are still larger than the returns generated by bonds
What conclusions can we take from the standard deviation regarding stocks and bonds?
Standard deviation of stock returns is higher than for bond returns over short-term holding periods (higher risk), but from a holding period of 15-20 years, stocks become less risky than bonds. The decrease of standard deviation has been faster than the one predicted if stocks follow a random walk, but not in the bonds and bills - mean reversion in the case of stocks and mean aversion in the case of bonds and bills
Even if stocks seem to be a better option, why can investors still want bonds?
The diversification may bring benefits, and even if bond and stock returns are negatively correlated, bonds may still serve to diversify a portfolio and lower overall risk
Regarding the recommended portfolio allocations, what are the main factors affecting the best percentage of an investor’s portfolio in stocks?
-risk tolerance
-holding period - increases as the holding period increases - if the percentage is higher than 100%, investors should contract debt to invest in stocks
If the holding period is a factor to consider when investing in stocks, why hasn’t it been considered?
if we assume that markets are efficient and follow the random walk, the holding period would be irrelevant
