Sunday, April 05, 2009

Strategies - Now the Long Run Looks Riskier, Too, for Investors -

First from the NY Times: Strategies - Now the Long Run Looks Riskier, Too, for Investors -
"...despite downturns like the one we’ve endured recently, stocks over periods of 30 or more years have almost always outperformed other asset classes. And numerous studies have found that the stock market’s long-term returns have tended to fall within a surprisingly narrow range.

But those studies were based on the stock market’s past performance, which, famously, provides no guarantee of future performance. New research, using different statistical techniques aimed at capturing the uncertainty of future returns, suggests that the market may be much riskier than many investors have understood....


One example of such a force, Professor Stambaugh said, is global warming. Its impact on the economy over the next 12 months is likely to be quite small, he said. But expand the horizon to the next several decades, and the possible effects of global warming range from negligible to catastrophic.


Applying Bayesian techniques, the professors found that reversion to the mean isn’t powerful enough to overcome the growing uncertainty caused by other factors as the holding period grows...."

The new study, which began circulating last month as a working paper, is titled “Are Stocks Really Less Volatile in the Long Run?”"
The paper is by Lubos Pasto and Robert Stambaugh:

"Conventional wisdom views stocks as less volatile over long horizons than over short horizons due to mean reversion induced by return predictability. In contrast, we find stocks are substantially more volatile over long horizons from an investor's perspective. This perspective recognizes that parameters are uncertain, even with two centuries of data, and that observable predictors imperfectly deliver the conditional expected return. We decompose return variance into five components, which include mean reversion and various uncertainties faced by the investor. Although mean reversion makes a strong negative contribution to long-horizon variance, it is more than offset by the other components. Using a predictive system, we estimate annualized 30-year variance to be nearly 1.5 times the 1-year variance. "

Pastor, Lubos and Stambaugh, Robert F.,Are Stocks Really Less Volatile in the Long Run?(February 17, 2009). Available at SSRN:

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