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Finance - Investments Sub-forum: Non-Actuarial Personal Finance/Investing

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  #11  
Old 11-10-2010, 01:31 PM
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Luckily for all of you, I am in my first ever finance course so I can answer this question for all of you.

In the long run, the standard deviation for returns on stocks is actually lower than the standard deviation for returns on even government bonds. But, the yield rate for stocks in the long run is still quite a bit higher. There is a nice chart in my finance book.

Stocks are riskier in the short term for sure, so you must be rewarded for this risk, or no one would buy them as has already been mentioned. But, you are not rewarded for the specific risk of a certain stock because you can get a well-diversified portfolio where most of that risk is gone. The risk that always remains is the risk of the market, and so you are rewarded by the market risk premium.
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  #12  
Old 11-10-2010, 01:45 PM
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Quote:
Originally Posted by apparition View Post
this should be simple, but here is what i think:

government bonds yiled the risk free rate

stocks yield a higher rate, but are also more risky.. the additional return should exactly offset the additional risk according to the no arbitrage principle.. so stocks yield the risk free rate as well in the long run

government bonds --> r
stocks --> r + additional risk + additional return

in the long run you shouldn't expect stocks to outperform bonds, should you? it is all the same.. no?
They may or they may not return more. What really matters is your time horizon, the expectations of others, and how much variance you can tolerate.

Current theory is garbage imo...

Last edited by The Obese Dog; 11-10-2010 at 01:49 PM..
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  #13  
Old 11-11-2010, 03:44 PM
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So if most people put money blindly into equity mutual funds with their 401(k) deposits, is it possible that so much extra money is in equities that the expected return is below the risk free rate? Do the really good investment advisors put money in US equities today? Part of stocks are based on expected return being > than treasuries, other variables include just basic supply demand principles. If blind money is going in, the expected return on capital can get very low. The more invested in index funds instead of being actively managed probably has an effect too.
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  #14  
Old 12-01-2010, 11:09 PM
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Originally Posted by apparition View Post
is that not what the risk-neutral measure is about?
No
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  #15  
Old 12-01-2010, 11:17 PM
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Originally Posted by Falco View Post
If stocks were to return the same as risk-free securities, wouldn't people prefer to hold the risk-free securities and avoid all the volatility?
Not if people were risk-neutral.
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  #16  
Old 12-02-2010, 10:12 AM
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Quote:
Originally Posted by ActSciMan View Post
There is a nice chart in my finance book.
do yourself a favor and ignore everything that is in that book
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  #17  
Old 12-02-2010, 01:25 PM
JUICE JUICE is offline
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Quote:
Originally Posted by apparition View Post
government bonds yiled the risk free rate
oh rly?

funny they are yielding so low while the default risk is clearly rising. does that imply a theoretical negative risk free rate?
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  #18  
Old 12-06-2010, 02:42 PM
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Originally Posted by JUICE View Post
oh rly?

funny they are yielding so low while the default risk is clearly rising. does that imply a theoretical negative risk free rate?
Maybe I'm misunderstanding but you do realize it's possible to create negative interest rates. In fact, it's been argued that creating negative interest rates should be considered in monetary policy.
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  #19  
Old 12-07-2010, 12:52 PM
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i was raising what i thought was an interesting point... a near-zero or even negative implied RFR would explain so many people holding cash, no?
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  #20  
Old 12-15-2010, 09:42 AM
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Quote:
Originally Posted by apparition View Post
this should be simple, but here is what i think:

government bonds yiled the risk free rate

stocks yield a higher rate, but are also more risky.. the additional return should exactly offset the additional risk according to the no arbitrage principle.. so stocks yield the risk free rate as well in the long run

government bonds --> r
stocks --> r + additional risk + additional return

in the long run you shouldn't expect stocks to outperform bonds, should you? it is all the same.. no?
Along the lines of the Duck.

Risk neutral - think of it as a math statement: For any risk proflie, the following is true...... and fill in the blank. A good example is put-call parity. It makes no difference whether you are risk averse or not, that formula holds.

The cool part of that statment is: If it's true for all risk postures, then if I solve the pricing problem with a completely risk averse posture, I get the "right" answer. Solving derivative pricing using rfr and a numeraire is a lot easier, so we do that.

Risk neutral has nothing to do with expected returns of assets. The whole discipline is about how to price derivatives, not underlying. I call RN valuation a giant and elegant interpolation machine. You cannot use it to price assets, only derivatives. It is interpolation because you want to find the price of a derivative that is not actively traded. (if it was actively traded, you don't need a formula, just look up the price!).

So we make big ol' stochastic formula that are ultimately calibrated to the observed prices of traded instruments in order to estimate the prices of related derivatives. No magic. Sadly, RN pricing will not make you rich - unless you can locate the pricing anaolies (arbitrage) and exploit them for instant profits. Good luck, on that, 'cuz you aren't the only one out there looking for those trades.
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