FATMA KARADOĞAN
TOHİR AKMALZODA
GÖKHAN SEYHAN
Submitted to : Assist.Prof. Dr. KORHAN GÖKMENOĞLU
Prepared by:
 Financial Market Returns From 1802
 The Long-Term Performance of Bonds
 The end of Gold Standard and Price Stability
 Total Real Returns
 Interpretation of Returns( Long-Term Returns)
 Short-term Returns and Volatility
 Real Returns on Fixed-Income Assets
 The Equity Premium
 Conclusion: Stocks for the Long-Run
 Stocks from 1802 to 1870
 Arithmetic and Geometric Returns
This chapter analyzes the
returns on stocks and
bonds over long periods of
time in both the United
States and other countries.
This two-century history
is divided into three
subperiods.
 In the first subperiod, from 1802 to 1870, the United
States made a change from an agriculture to an
industrialized economy, comparable to the change
that the “emerging markets” of Latin America and
Asia are making today.
 In the second subperiod,from 1871 to 1925, the
United States became the foremost political and
economic power in the world.
 The third subperiod, from 1926 to 1932 stock
collapse, the Great Depression,and the postwar
expansion.
 Bonds are the most important financial assets
competing with stocks.
 Bonds promise fixed monetary payments over time.
In contrast to equity, the cash flows from bonds have
a maximum monetary value set by the terms of the
contract.
This is the Interest rate fluctuations during the nineteenth
and twentieth centuries remained within a narrow range.
During the Great Depression of the 1930s, short-term
interest rates fall,nearly to zero, and yields on long-term
government bonds fall to a record low of 2 %.
From 1802 to1929 the level ofinterest rates is closely tied to
the level of inflation. The returns on fixed-income assets
therefore requires knowledge of how inflation is
determined .
 A monetary system in which a country's government
allows its currency unit to be freely converted into
fixed amounts of gold and vice versa. The exchange
rate under the gold standard monetary system is
determined by the economic difference for an ounce
of gold between two currencies. The gold standard
was mainly used from 1875 to 1914 and also during
the interwar years
 Figure 1-4 shows the growth of purchasing power,
or total real returns, in the same assets that were
graphed in Figure 1-1: stocks, bonds, bills and gold.
 Despite ex-traordinary changes in the economic,
social, and political environment over the past two
centuries, stocks have yielded between 6.6 and 7.0
percent per year after inflation in all major
subperiods.
 The real return on equities has averaged 6.8 percent
per year over the past 204 years.
 Note the extraordinary stability of the real return on
stocks over all major subperiods: 7.0 percent per year
from 1802 through 1870, 6.6 percent from 1871
through 1925, and 6.8 percent per year since 1926.
 This is virtually identical to the previous 125 years,
which saw no overall inflation. This remarkable
stability is called the mean reversion of equity
returns, which means that returns can be very
unstable in the short run but very stable in the long
run. (1802-1926)
 Figure 1-4. When the total real return on stocks was
substantially above the trend line, such as during the
late 1960s and 1990s
 The United States evolved from an agricultural to an
industrial economy and then to the post industrial,
service and technology oriented economy it is today.
 The bull market from 1982 through 1999 gave
investors an extraordinary after-inflation return of
13.6 percent per year, which is double the historical
average. This constituted the greatest bull market in
U.S. stock market history.
 Nevertheless, this bull market carried stocks too
high, as total real returns in Figure 1-4 reached 81
percent above the trend line.
 The nominal and real returns on both short-term and
long-term bonds are reported in Table 1-2 covering
the same time periods as in Table 1-1.
 The real return on bills has dropped precipitously
from 5.1% in the early part of the nineteenth century
to a bare 0.7% since 1926.
 The real return on long-term bonds has shown a
similar pattern.Bond returns fell from a generous
4.8% in the first subperiod to 3.7% in the second, and
then to only 2.4% in the third.
 You have to go back the period from 1831 through
1861 to find any 30-year period during which the
return on either long- or short-term bonds exceeded
that on equities. The dominance of stocks over fixedincome securities is overwhelming for investors with
long horizons.
 There were some reasons for the decline in the real
return on fixed-income assets over the past century,
but it is very likely that the real returns on bonds
will be higher on average in the future than they
have been since the end of World War 2.
 Over the past 200 years the compound annual real
return on a common stock is nearly 7% in US, and it
has shown a wonderful constancy over time.
 The reasons for the constancy and long-term stability
of stock returns are not well understood.
 The superior returns to equity over the past two
centuries might be explained by the growing
dominance of nations committed to free market
economics.
 The first actively traded US stocks, floated in 1791,
were issued by bank of New York and the Bank of
the United States. Both offering were successful and
were quickly bid to a premium.
 The average arithmetic return is the average of each
yearly return.
 The geometric return is approximately equal to the
arithmetic return minus one half the variance of
yearly returns.
 The average geometric return is always less than the
average arithmetic return except when all yearly
returns are exactly equal. This difference is related to
the volatility of yearly returns.