History Of Interest Rates And Risk Premiums

Individuals must be concerned with both the expected return and the risk of the assets that might be included in their portfolios. To help us form reasonable expectations for the performance of a wide array of potential investments, this chapter surveys the historical performance of the major asset classes. It uses a risk-free portfolio of Treasury bills as a benchmark to evaluate that performance. Therefore, we start the chapter with a review of the determinants of the risk-free interest rate, the rate available on Treasury bills, paying attention to the distinction between real and nominal returns. We then turn to the measurement of the expected returns and volatilities of risky assets, and show how historical data can be used to construct estimates of such statistics for several broadly diversified portfolios. Finally, we review the historical record of several portfolios of interest to provide a sense of the range of performance in the past several decades.

132 PART I Introduction

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