December 2009 Archives
Dec 14, 2009
Q & A
Lubos Pastor and Robert Stambaugh argue that long-horizon stock investors actually face more volatility than short-horizon investors. How should investors interpret this evidence?
KRF: The Pastor-Stambaugh result is driven by uncertainty about the true expected return. The volatility or standard deviation of returns is usually defined as the expected variation relative to the true mean of the process generating returns - as if we knew the true expected return. But, as Pastor and Stambaugh emphasize, we never actually know the true mean. When they include uncertainty about the true mean (as well as uncertainty about other true parameters) in the analysis, they find that long-run returns are indeed more volatile than short-run returns.
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Dec 8, 2009
Q & A
Real economic risk appears to have decreased over time as global economies have become more advanced and diversified. But market risks appear to have increased due to innovative financial instruments with unexpected characteristics. Is financial innovation a good thing?
EFF/KRF: We do not agree with the reading of the facts in this question. We know of no solid evidence that market risks have increased relative to the risks of real economic activity. Market volatility and the volatility of real economic activity were both extremely high in the great depression, and both declined thereafter. During the post WWII period, market volatility tends to increase during recessions, along with (and typically in advance of) the volatility of real economic activity. From 2002 to late 2007 the volatility of real activity was low and market volatility hit all time lows. With the subsequent onset of a severe recession, market volatility increased, along with uncertainty about future real economic activity.
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ABOUT FAMA AND FRENCH
Eugene F. Fama
The Robert R.
McCormick Distinguished
Service Professor of
Finance at the University
of Chicago Booth School
of Business
Kenneth R. French
The Roth Family Distinguished Professor of
Finance at the Tuck
School of Business at
Dartmouth College
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Dimensional Fund Advisors Ltd. is authorised and regulated in the United Kingdom by the Financial Services Authority (FRN: 150100), is registered in England and Wales under Company No. 02569601 and VAT No. 577327607. The registered office address of Dimensional Fund Advisors Ltd. is 7 Down Street, London, W1J 7AJ, United Kingdom. Dimensional Fund Advisors Ltd. is a subsidiary of Dimensional Fund Advisors.