fAJ Financial Analysis Journal

Volume 62 • Number 6
©2006, CFA Institute

The Misuse of Expected Returns

1
Eric Hughson, Michael Stutzer, and Chris Yung

Much textbook emphasis is placed on the mathematical notion of expected return and its historical
estimate via an arithmetic average of past returns. But those wanting to forecast a typical future
cumulative return should be more interested in estimating the median future cumulative return
than in estimating the mathematical expected cumulative return. For that purpose, continuous
compounding of the mathematical expected log gross return is more relevant than ordinary
compounding of the mathematical expected gross retum.

P
opular finance textbooks and other method- namely, compounding the arithmetic average to
ological treatises emphasize the relevance of produce cumulative retum forecasts at each future
a portfolio's expected retum and the use of horizon between 1 and 30 years. For example, the
time-averaged historical returns as an esti- forecasted cumulative retum after 1 year is 1.054^
mate of it. For example, Bodie, Kane, and Marcus = 1.054, and after 30 years, it is 1.054^0 = 4799. that
(2004) state: is, an initial investment of SI.00 is forecasted to
... if our focus is on future performance then grow to about $4.80. But this retum forecast is far
the arithmetic average is the statistic of interest higher than the 30-year historical cumulative
because it is an unbiased estimate of an asset's retum (3.005) shown at the bottom of the last col-
future returns, (p. 865) umn, which suggests that the arithmetic average-
A more detailed procedure for using this average based forecast in the fourth column may be too
is found in a respected researcher's survey article: high. We will now document that such overblown
forecasts are very likely to happen in practice.
When returns are serially uncorrelated—that
is, when one year's retum is unrelated to the The overoptimism inherent when the arith-
next year's retum—the arithmetic average metic average retum is used to forecast is illus-
represents the best forecast of future retum in trated in Table 2 and Figure 1, which report the
any randonUy selected year. For long holding results from a bootstrap simulation of one million
periods, the best return forecast is the arith- possible future cumulative retums derived from
metic average compounded up appropriately. the annual gross returns given in Table 1.^ Both
(Campbell 2001, p. 3)
Tabie 2 and Figure 1 clearly show that the mathe-
For an illustration of the quoted concepts, con- matical expected cumulative return is always
sider a hypothetical broad-based stock index with higher than the median cumulative retum (i.e., the
returns that are corxsistent with the ubiquitous ran- retum that has equal chances of being exceeded or
dom walk hypothesis. Annual gross (i.e., 1 plus net) not) and that the gap between the two increases as
retums for each of the past 30 years from the hypo- the time horizon lengthens and the cumulative
thetical index are given in the second column of retum distribution becomes more highly skewed to
Table 1. The arithmetic average gross retum is the right. For example, at the 10-year horizon, the
1.054 (i.e., the net retum averages 5.4 a year). The mathematical expected cumulative retum is 1.72,
last column provides the historical cumulative which is 18 percent bugher than the median cumu-
retums. The fourth column of Table 1 shows the lative return (1.46). At the 30-year horizon, the
cumulative retum forecasts calculated by follow- mathematical expected cumulative retum is 67 per-
ing the advice in the Campbell (2001) quotation— cent higher than the median cumulative retum. As
a result, the mathematical expected cumulative
return is less likely to be realized (i.e., met or
Eric Hughson and Chris Yung are professors of finance
exceeded by the future cumulative retum) in the
in the Leeds School of Business at the University of
future than the median retum, and this likelihood
Colorado, Boulder. Michael Stutzer is professor of
is more pronounced for the long horizons used by
finance and director oftheBurridge Center for Securities
Analysis and Valuation in the Leeds School of Business
retirement planners. For example, there is a 38 per-
at the University of Colorado, Boulder.
cent probability that the mathematical expected

88 www.cfapubs.org ©2006, CFA Institute

 The Misuse of Expected Returns

Table 1. Forecasts Based on Historical Arithmetic Average Returns

Historical Period, T Gross Lx)g Gross T-Year Ctunulative Historical
{years) Retum Retum Retum Forecast Cumulative Retum
1 1.014 0.014 1.054 1.014
2 0.876 -0.133 1.110 0.888
3 1.100 0.095 1.170 0.976
4 1084 0.250 1.233 1.254
5 1.269 0.239 1.299 1.592
6 1.375 0.319 1.368 2.189
7 0.764 -0.269 1.442 1.673
8 1.024 0.024 1.519 1.713
9 1.250 0.223 1.601 2.141
10 0.901 -0.104 1.687 1.929
11 0.956 -0.045 1.777 1.845
12 0.823 -0.195 1.873 1.518
13 0.804 -0.218 1.973 1.221
14 0.916 -0.088 2.079 1.118
IS 0.944 -0.057 2.191 1.056
16 0.772 -0.259 2.308 0.815
17 0.974 -0.026 2.432 0.794
18 0.998 -0.002 2.563 0.792
19 1.082 0.079 2.700 0.857
1.004 0.004 2.845 0.861
21 1.010 0.010 2.998 0.869
22 1.003 0.003 3.159 0.872
23 1.297 0.260 3.328 1.131
24 1.047 0.046 3.507 1.184
2S 1.031 0.031 3.695 1.221
2£ 0.982 -0.018 3.893 1.199
27 1.426 0.355 4.102 1.709
28 1.208 0.189 4.323 2.064
29 1.515 0.415 4.555 3.126
30 0.961 -0.039 4.799 3.005

Average 1.054 0.037

Table 2. Forecasting the Mathematical Expected and Median T-Year

Cumulative Return
Compounded Compotmded
Horizon Mathematical Arithmetic Average
(Tyears) Expected Retum Average Retum Median Retum Log Retum
5 1.31 1.30'' 1.20 1.203*'
10 1.72 1.69 1.46 1.45
20 3.01 2.86 2.18 2.10
30 5.15 4.84 3.09 3.03
40 9.0] 8.20 4.72 4.39

November/December 2006 www.cfapubs.org 89

Financial Analysts Journal

Figure 1. Mathematical Expected Return vs. Median Cumuiative Return:

Bootstrap Simuiation of Table 1 Returns

A. 5-Year Cumulative Returns B. lO'Year Cumulative Returns

Frequency Frequency i
7,000

0 1.0 2.0 3.0 4.0 0 1.0 2.0 3.0 4.0 5.0

Cumulative Return Cumulative Return

C. 20-Year Cumulative Returns D. 30-Year Cumulative Returns

Frequency Frequency

40,000 80,000
70,000
60,000
50,000
40,000
30,000
20,000
10,000
0
0 2.5 5.0 7.5 10.0 12.5 15.0 5.0 10.0 15.0 20.0 25.0 30.0
Cumulative Return Cumulative Return

E. 40-Year Cumulative Returns

Frequency
140,000

5.0 10.0 15.0 20.0 25.0 30.0

Cumulative Return
Median Cumulative Return Expected Cumulative Return

90 www.cfapubs.org ©2006, CFA Institute

 The Misuse of Expected Returns

cumulative retum will be exceeded at the 10-year Why Use the Arithmetic Average
horizon and only a 30 percent probability that it
will be exceeded at the 30-year horizon. Return In Forecasting?
The third column in Table 1 contains the loga- Two motives are put forth for using the arithmetic
rithms of the historical gross retums. The average of average retum, but neither is convincing. The first
these logarithms is lower than the arithmetic aver- motive is somewhat complex. Recall that the mathe-
age of the gross retums themselves. Table 2 con- matical expectation of something is the probability-
trasts forecasts that compound the arithmetic weighted average of its possible values. The
average gross retum with those that (continuously) quotations that began this article use this mathemat-
compound the average hg gross retum (3.7 percent ical definition of expectation. When portfolio gross
from Table 1). It is also common for analysts to call retums K, are independently (I) and identically dis-
the number e^-^^'^ - 1 == 0.038 percent the geometric tributed (ID), the mathematical expected cumula-
average net retum, in which case the last column of tive retum (denoted by E) is the compounded value
Table 2 is equivalently produced by ordinary com- of the expected gross retum per period—that is,
pounding of the geometric average gross retum (i.e.,
1.038'),^ Table 2 shows that the compounded aver- (0 ?• (ID)
age of the log gross retums is far closer to the simu- { ) Yt=] l { )
lated median future cumulative retum than is the
compounded arithmetic average (1.054^), which in where Wj denotes the (random) cumulative return
tum, is far closer to the simulated mathematical T periods in the future.
expected future cumulative return. At the relatively In addition, with the same IID assumption, the
long horizons that characterize retirement planning, arithmetic average of historical gross retums is a
the unwarranted optimism inherent in the arith- commonly used estimate of the (unknown) con-
metic average-based forecasts will probably lead to stant mathematical expected gross retum E{Ri) per
excessively high investment in stocks. period, which becomes a more accurate estimate as
To confirm that these problems also occur the calendar history of gross retums lengthens.
when actual monthly historical returns are used, we This argument is the typical motivation (as used in
applied the same bootstrap simulation technique to the opening quotation) for substituting the arith-
the widely used 1926-2004 large-capitalization metic average gross retum (i.e., 1.054 percent) for
stock monthly retums produced by CRSP. The the unobserved expected gross retum per period,
results, depicted in Figure 2 and Table 3, confirm EiRx).^ But as Figures 1 and 2 and Tables 2 and 3
the previous problems. Moreover, a proof in show, the mathematical expected cumulative
Appendix A shows that these phenomena are return, E{Wj), for a stock index is less likely to be
generic, not simply the result of the specific data or equaled or exceeded than the median cumulative
accuracy of the simulations.
retum is. The situation becomes extreme in the long
These findings are important because some
run because, as proven in Appendix A,
investors do use the overly optimistic forecast pro-
cedure based on the historical arithmetic average.
For example, in 2001, the chief actuary of the U.S. pwb[Wj->E{Wj-)] = 0.
Social Security Admirustration described forecast So, perhaps some long-term investors want to
procedures used in the organization's study of indi- forecast the expected cumulative retum because
vidual retirement account options that had been they use the word "expected" in its dictionary
proposed but notyet enacted. The actuary noted that sense, rather than its mathematical sense. Accord-
for individual account proposals, analysis of ing to the Merriam-Webster Online Dictionary,
expected benefit levels and money's worth "expect" means "to anticipate or look forward to
was aiso provided using a higher annual
equity yield assumption of about 9.6 percent. the coming or occtirrence of" or "to consider prob-
This higher average yield reflected the arith- able or certain." Long-term investors using this
metic mean, rather than the geometric mean sense of the word will want to forecast the median
(which was 7 percent), of historical data for cumulative retum rather tlian the mathematical
annual yields. (Campbell 2001, pp. 55-56) expected cumulative return because the unknown
In other words, the actuary made separate forecasts future cumulative retum is more likely to equal or
by compounding equity accounts at both the 9.6 exceed the median. Tables 2 and 3 suggest that such
percent historical arithmetic average retum and the investors should continuously compound the aver-
7 percent geometric average retum. We now exam- age log gross retum (or, equivalently, simply com-
ine possible reasons for compounding at the histor- pound the geometric average retum) when making
ical arithmetic average retum rate. forecasts based solely on historical data.

November/December 2006 vvwvtf.cfapubs.org 91

Financial Analysts Journal

Figure 2. Mathematical Expected vs. Median Cumulative Return: Bootstrap

Simulation of (1926-2004) Large-Cap Stock Returns

A. 60-Month Cumulative Retums B. 120-Month Cumulative Retums

Frequency Frequency

8,000
7,000
r 16,000
14,000

6,000
5,000
-\ \
A
12,000

10,000
\

\
4,000 8,000
]\
3,000 6,000
\ \
2,000 4,000

Jj .
1,000 2,000

0 0
1.0 2.0 3.0 4.0 5.0 6.0 7.0 2.0 4.0 6.0 8.0 10.0 12.0
Cumulative Return Cumulative Retum

C 240-Month Cumulative Retums D. 360-Month Cumulative Retums

Frequency Frequency
I^ii f)(¥l
4U,UUU

35,000 r i\
1 100,000
30,000 l\
\
25,000 •I I 75,000
20,000 -I \
50,000
15,000 > \

10,000 W
25,000
5,000 vi \ ^
0 1 0
30.0 40.0 50.0 0 25.0 .JO.O 75.0 lro.O 125.0 150.0
e Retum Cumulative Retum

E. 480-Month Cumulative Retums

Frequency
1 t n nnn
loU/UUU

A
A
140,000
120,000
100,000
80,000
60,000
\
40,000 •
\
20,000 -

^ _
0 1. 1 .1. ^ ^ ^ ^

100.0 200.0 300,0 400.0

Cumulative Retum

Median Cumulative Retum Expected Cumulative Retum

92 www.cfapubs.org ©2006, CFA Institute

 The Misuse of Expected Returns

Table 3. Forecasting Based on Monthly (1926-2004) Large-Cap Returns

Compounded Compounded
Horizon Mathematical Arithmetic Average
(T years) Expected Return Average Return Median Return Log Return
5 1.79 1.82^ 1.64 1.62^
10 3.22 3.30 2.68 2.64
20 10.35 10.89 7.16 6.96
^' 33.26 35.95 19.08 18.38
40 106.69 118.65 50.83 48.51

A second possible motive for interest in fore- Hence, they act "as if" the forecast loss is the fore-
casting the mathematical expected cumulative cast error itself, rather than the squared error.
rehim arises from the statistical theory of best fore-
casts. This theory requires that the forecaster
choose a loss function that quantifies the loss Limitations of Historical Returns
incurred by missing the forecast. Of course, the Unfortunately, using a historical average to estimate
forecast error is random, so the best forecast is the either the unknown expected gross return per year
one that minimizes a misforecasting "cost," or expected log gross return per year requires, even
defined to be the mathematical expected loss. under the ideal statistical circumstances embodied
When the loss is proportional to the squared forecast in the IID assumption, a very long calendar history
error, it is well known (see, for example, Zellner of returns. Under the IID assumption, the estimate
1990) that the best forecast, m this sense ofthe word becomes progressively more accurate as the number
"best," is the mathematical expected cumulative of available past years' returns gets larger. But the
return, despite the fact that it will be higher than convergence to the unknown true number is typi-
the median cumulative return. To understand why, cally slow. Measuring returns more frequently (e.g.,
consider the loss associated with underforecasting monthly or daily instead of annually) does abso-
an unusually high cumulative return. The loss is lutely no good."*
extremely high because it is found by squaring the For an illustration of this point, note that the
error between the high cumulative return and the hypothetical annual stock returns in Table 1 (and
(lower) forecast. For example, suppose the forecast used to produce Figure 1 and Table 2) were ran-
error is +3. Then, the loss is 9, which is three times domly sampled from a lognormal distribution
the size of the forecast error itself. Now, because with a volatility of 15 percent. Suppose we would
cumulative returns are inherently positively like to be 95 percent confident that the historical
skewed, the chance of underforecasting by an average log gross annual return is within 400 bps
unusually large amount is greater than the chance of the (unknown) expected log gross return per
of overforecasting. As a result, to minimize the year. Appendix A shows that we would need more
chance of underforecasting by an unusually large than 54 years of past log gross returns to ensure this
amount, the forecast that minimizes the mathemat- confidence level. And ±400 bps per year is probably
ical expected squared forecast error will be higher too wide an uncertainty band for many financial
than the median. But this mathematical result is planning purposes.
merely an alternative way of characterizing the Moreover, even if we did have a long calendar
behavior of someone who uses the expected cumu- history of returns, how likely is it that those returns
lative return as a forecast. It is not a recommenda- would continue being generated by the same IID
tion that investors use the squared forecast error to process? If the probability distribution of the mea-
measure the loss from misforecasting. In fact, stat- sured returns changes over time, the compounding
isticians have also shown that if investors use the of historical averages will be very misleading, espe-
forecast error itself to measure the loss from mis- cially for short- or medium-term forecasts. Asness
forecasting, the median is the statistically best fore- (2005) noted:
cast. After seeing the results in this article, we
believe that most long-term investors would con- When it comes to forecasting the future,
sider the median cumulative return to be a better especially when valuations (and thus histori-
cai returns) are at extremes, the answers we
forecast than the expected cumulative return. get from looking at simple historical averages
are bunk. (p. 37)

November/December 2005 www.cfapubs.org 93

Financial Analysts Journal

This opinion may be excessively harsh, but we do (I) T (ID)

feel that using historical returns to implement non- l (A2)
parametric forecast procedures (such as all the ones
mentioned in this article) does not solve all prob- which shows that compounding expected portfolio
lems inherent in the difficult task of forecasting gross returns produces the portfolio expected
cumuiative returns. cumulative return, a fact underlying the Campbell
(2001) quotation at the beginning of this article.
Conclusion Representing Equation Al and Equation A2 a
bit differently will soon prove useful. To do so, we
Textbooks and other methodological sources may take the logarithm of both sides of Equation A2 and
discuss the mathematical differences between his- then reexponentiate to show that
torical arithmetic average and geometric average
returns but may not adequately advise practitioners ,^r^iog£(fl)
about the proper use of these concepts when fore- (A3)
casting future cumulative returns. Under ideal sta- Taking the logarithm of both sides of Equation Al,
tistical assumptions, the historical arithmetic dividing and multiplying by T, and then reexpo-
average gross return is an unbiased estimator of the nentiating shows that
mathematical expected gross return per period. As
others have noted, compounding the mathematical
expected gross return (but not the historical arith- (A4)
metic average return) produces the mathematical
expected cumulative return. But because cumulative We see from Equation A4 that it is the time-
returns are positively skewed, the mathematical averaged log gross returns that determine the evo-
expected cumulative return substantially overstates lution of a portfolio's cumulative return, regardless
the future cumulative return that investors are of whether or not the returns are IID. Because the
likely to realize, and the problem grows worse as (nonlog) gross returns are never negative for stock
the horizon increases. Those seeking a more realistic and/or bond investments, and raising something
forecast procedure can approximate the median normegative to a fixed power greater than 1 is a
cumulative return by continuously compounding monotone nondecreasing function. Equation A3
the mathematical expected log gross return per and Equation A4 imply that the probability of doing
period, using the historical average log gross return at least as well as the expected cumulative return is
to estimate the expected log gross return. Without a
hundred years or more of accurate returns to aver-
age, however, that procedure may still provide a = proh (A5)
T
highly inaccurate estimate—even if the return dis-
tribution does not change over time. But by the law of large numbers for HD pro-
cesses, j
Vie authors wish to acknowledge Gitlt Gur-Gershgorin I r r^-
for assistance loith the simulations and Garland — ^ l o g / ? , - E{\ogR). (A6)
Durimm for comments on the mathematics. ^f=i
So, from Equation A5 and Equation A6, we see
This article qualifies for 1 PD credit. that the long-run behavior of the probability (Equa-
tion A5) is governed by the relationship between
£(log R) and log £(R). Because Jensen's inequality
Appendix A. Derivation of implies that
E(\QgR)< \ogE[R), (A7)
Mathematical Claims
Using Wj to denote the cumulative return in time Equations A5-A7 imply the distribution-free result
period T from a dollar invested initially and using in the text; that is,
Rf to denote the gross return at time t {i.e., 1 plus
the net return), we express Wj- as pToh[WT>E(Wjj\ = 0. (A8)
Erom Equation A8, we can clearly see that we
should not expect to earn a long-run cumulative
return that is greater than or equal to the expected
When the gross return process is IID, the ma th- cumulative return! When a variable is not symmet-
ematical expectation (denoted by £) is rically distributed, its mathematical expectation is

94 www.cfapub5.org ©2006, CFA Institute

 The Misuse of Expected Returns

not generally a good indicator of the variable's

central tendency. Figures 1 and 2 show that the 1 (A13)
cumulative return distribution is sharply skewed for all horizons T (i.e., there would be no tendency
to the right, so the expected cumulative return, for the investment value to drift either up or down,
E{Wj), is higher than what will likely occur. despite the seemingly high expected cumulative
The horizon-dependent probabilities (Equa- return e^-^^^). An investment with a smaller ii
tion A5) are easily calculated when the returns are would result in negative drift (i.e., a tendency to
lognormally distributed, as the hypothetical returns lose money). However, a more diversified portfolio
used in Table 1 are. Substituting our notation for with a smaller return (|a < 8 percent) would tend to
that used by Hull (1993, p. 211), log Wj is normaUy make money if its volatility were low enough to
distributed with mean equal to (|i - a^/2)T and
variance equal to crT, where |i andCTare, respec- But what about when log R is not normal? We
tively, the annualized mean and volatility parame- will now see why compovmding the average log
ters. Hull also showed that return produces a reasonable estimate of the
median cumulative return whether the IID distri-
bution of log R is normal or not. First, we rewrite
(A9)
Equation A4 by canceling T to obtain
(that is, the compound value of the expected gross
return). Similarly, ^ (A14)
Because the exponential function is a mono-
E(\ogWT) = (\i-o-^/2)T. (A]0) tone (increasing) function of T ^
Because the logarithm is a monotone increas-
ing transformation.
Median (AIS)
When Tis suitably large, Ethier (2004) used the
following approximation:
= prob Z>
(All) Median] , = E{\ogR)T
)
= prob

where Z denotes the standard normal density func- 6 var (log R)

tion. We see that prob[W7-> EiWj-)] approaches zero In practice, the second term in Equation A16 is
as the horizon, T, approaches infinity, as proven for quite small compared with the first term. So, sub-
the arbitrary distributions. stituting Equation A16 into Equation A15 yields
Fortunately, prob[W7- > Median{Wj)] = 1/2,
instead of approaching 0 for large T. When the Hull Median (A17)
(1993, p. 211) lognormal example is used, the
It is easy to show the equivalence between
median cumulative return is (?(M-CT-/2)r. ^^i^^ jg^ it
compounding the historical average log gross
is produced by compounding the expected log
return and compounding the historical geometric
gross return per year. The percentage difference of average net return. Denote the actual historical
the expected and median cumulative returns is rehirns by R\ R'I^ and the historical cumula-
-17" tive return by W'. Then, the historical geometric
average, R{g), is defined by
(A12)
(A18)

But W can also be computed by

which is an increasing function of a and T.
A particularly stark example of the difference
(A19)
between the expected and median cumulative
returns can be seen by considering a volatile invest- Equation A18 and Equation A19 show that
ment (e.g., fi = 8 percent and a = 40 percent). Then,
the median cumulative return is i= e
(A20)

November/December 2006 www.cfapubs.org 95

Financial Analysts Journat

so raising either side of Equation A20 to the power measure log retums I/At times per year {e.g.. At =
T produces the same T-period cumulative retum 1/12 when retums are measured monthly). Then,
forecast—a "plug-in" estimator of Equation A17. If the log gross retum per measurement period has an
R, is used to denote a generic random historical expected value of (^ - a^/2)Af, so a historical aver-
gross retum, a desirable property of this plug-in age of N s T/At log gross retums (i.e., T years of
estimator is that history) will also be normally distributed with an
expected value equal to (fj - o^/2)A(. Hence, an
Median (A21) unbiased estimator of ^ -CT^/2is the historical aver-
Median = e
age log gross retum divided by Af. Because the log
which we dub "median unbiasedness." A more gross retum per measurement period has a variance
complex procedure might provide a better estimator of a^Af, the variance of the unbiased estimator is
of the median cumulative retum, but simplicity of <y^{Atf/T divided by {AO^ which equals a^/T and
implementation and motivation are practitioners' is hence independent of the retum measurement
desiderata that would be implicitly ignored by those interval, Af. A 95 percent confidence interval for
(if any) who advocated a more complex procedure.
the historical average will then have a width of
Unfortunately, historical arithmetic or geomet-
± 1.96o/ Jf. For that width to be +0.(K, T would have
ric averages are inherently imprecise estimators—a
fact that is easily illustrated under lognormality. to be 0^(1.96/0.04)2 ^^^^.^ SubsHtutingCT= 0.15
The log of the one-year cumulative retum distribu- yields 54 years, no matter how frequently retums are
tion has an expected value oi\i- cr/2. Suppose we measured, as claimed near the end of the text.

Notes
T random draws from the annual gross retums in Table 1 ematical expected cumulative return, They added tbe
were multiplied to produce a possible T-year cumulative assumption that returns are lognormally distributed and
retum. Tbe procedure was repeated one million times to proposed better estimators of the unknown mathematical
produce eacb of the smootbed histograms in Figure 1, expected cumulative retum. Our goal is different, however,
whose means and medians are reported in Table 2. for we are highlighting flaws in the arguments used to justify
See Appendix A for a derivation of this equivalence and the the relevance of estimating tbe mathematical expected
other mathematical claims made later in the text. cumulative retum in the first place. We argue that estimat-
Even this typical motivation is flawed. An interesting article ing the median cumulative retum is a much more relevant
by Jacquier, Kane, and Marcus (2003) highlighted problems objective, regardless of whether the returns are lognormal.
resulting from compounding the historical arithmetic aver- See Luenberger (1998) for a simple exposition of this prob-
age to produce a data-based estimate of tbe unknown math- lem and Appendix A for a specific calculation.

References
Asness, Clifford S. 2005. "Rubble Logic: Wbat Did We Leam Hull, Jobn. 1993. Options, Futures, and Other Derivative Securities.
from the Great Stock Market Bubble?" Financial Analysts joiirmi, Upper Saddle River, NJ: Prentice Hall.
vol. 61, no. 6 (November/December) ;36-54. Jacquier, Eric, Alex Kane, and Alan Marcus. 2003. "Geometric
Bodie, Zvi, Alex Kane, and Alan Marcus. 2004. Essentials of Mean or Arithmetic Mean: A Reconsideration." Financial
Invesiments. 6th ed. New York: McGraw-Hill. Analysts journal, vol. 59, no. 6 (November/December):46-53.
Campbell,JobnY. 2001. "Forecasting U.S. Equity Returns in the Luenberger, David G. 1998. Investment Science. New York:
21st Century." In Estimating lhe Real Rate of Return on Stocks over Oxford University Press.
the long Term. Edited by Jobn Y. Campbell, Peter A, Diamond, Zellner, Arnold. 1990. "Bayesian Inference." In The New Palgrave:
and Jobn B. Shoven. Social Security Advisory Board Time Series and Statistics. Edited by John Eatwell, Murray
(www.ssab.gov/publications.htm). Milgate, and Peter Newman. New York: Norton.
Ethier, S.N. 2004. "The Kelly System Maximizes Median
Fortune." Journal of Applied Probability, vol. 41, no. 4
(December): 1230-1236.

96 www.cfapub5.org ©2006, CFA Institute