Friday, November 21, 2008

A century of returns

One of the books I'm working through this moment, Quantitative Financial Economics, has a chapter (4) on stock returns. It starts off with a distribution of S&P500 monthly returns for the period from Feb. 1915 to Apr. 2004.

I can't post the graph here since I only have the physical book, but I will state the obvious points suggested by the century long return distribution.

Returns have a negative skew- Heteroscedasticity (volatility) usually increases as prices decline. The left side reashs -0.15 while the right hand side dies off at roughly 0.13.

Volatility is conditionally autoregressive- When volatility is high, it tends to stay high for some time, and simlary for low volatility periods.

Now we can see how the market functions to extract wealth from the uninformed investors. The slow and minimal upside returns lure them in, then the sharp corrections blow their accounts and transfer their wealth to those on the other side of the trades. It's a good system, as long as you're not the patsy.

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