Introduction Data Javier Estrada Price indices v . Total return - - PDF document

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Introduction Data Javier Estrada Price indices v . Total return - - PDF document

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Application 1: Background Mean Returns Javier Estrada ADFIN Winter/2014 1. Introduction The relevance of dividends 2. Mean Returns Calculations The relationship between AM, GM, and SD The relationship between AM, GM, and

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Application 1:

Background – Mean Returns

Javier Estrada ADFIN – Winter/2014

  • 1. Introduction
  • The relevance of dividends
  • 2. Mean Returns
  • Calculations
  • The relationship between AM, GM, and SD
  • The relationship between AM, GM, and forecasting
  • The relationship between GM, DWM, and market timing

Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014

Introduction

  • Data
  • Price indices v. Total return indices
  • Public sources publish price indices
  • Careful if you assess performance by using data from

Yahoo Finance, Google Finance, newspapers, …

 Public sources typically omit dividends

Go

  • Why are dividends important?
  • S&P‐500 (1900‐2013)
  • AM(TR):

11.5%

  • AM(PI):

7.0%

  • Difference:

4.5% a year

  • Taking out 39% of the return in the average period

takes out ‘a bit’ more than 39% of long‐term terminal wealth

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Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014

Introduction – S&P 500

TR PI

Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014

Introduction – S&P 500

$33,254 $307

Remember the importance of …

⦁ dividends ⦁ reinvesting dividends

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Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014

AM, GM, and SD – Excel Commands

  • Returns
  • TR indices  Rt = It/It‐1–1 yields the total return
  • Some useful Excel commands
  • Count

→ ‘=COUNT(Range)’

  • AM

→ ‘=AVERAGE(Range)’

  • SD

→ ‘=STDEV(Range)’ or ‘STDEVP(Range)’

  • Arrays
  • GM

→ With the PRODUCT array → With the GEOMEAN array

GoXls Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014

AM, GM, and SD

  • Recall two important facts
  • AM ≥ GM (Virtually always → AM > GM)
  • AM–GM = f+(Volatility)
  • The whole point of Q3 was to explore the

relationship between AM, GM, and SD further

  • Two important issues for portfolio optimization
  • GM as a function of AM and SD
  • Variance drag (GMM)

GoXls

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Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014

AM, GM, and Forecasting

  • Forecasting
  • Blume’s formula
  • Combines the AM and the GM in a return forecast

‐ T = Number of observations in the sample ‐ N = Number of periods ahead for which the forecast is made

Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014

GM, DWM, and Market Timing

  • Recall …
  • the critical distinction between …
  • investment return (GM)
  • investor return (DWM)
  • it is possible that DWM>GM or DWM<GM
  • whether DWM>GM or DWM<GM depends on

investors’ ability to time the market

GoXls

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Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014

GM, DWM, and Market Timing

During his 13 years managing the Fidelity Magellan fund, Peter Lynch provided investors with a 29% 29% annualized return. During the same period, half half of the investors in Magellan lost lost money.

Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014

GM, DWM, and Market Timing

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Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014

GM, DWM, and Market Timing

Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014

GM, DWM, and Market Timing