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Questions and Answers
What defines a bubble in stock market terms?
What defines a bubble in stock market terms?
In which year did the first great stock market bubble in France burst?
In which year did the first great stock market bubble in France burst?
What constitutes a 'boom' in stock market analysis?
What constitutes a 'boom' in stock market analysis?
According to the data presented, what percentage of markets experienced returns over 100%?
According to the data presented, what percentage of markets experienced returns over 100%?
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What is a clear indicator of a bubble regarding price dynamics?
What is a clear indicator of a bubble regarding price dynamics?
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What is the conditional frequency of a market doubling in the subsequent year after a 100% return?
What is the conditional frequency of a market doubling in the subsequent year after a 100% return?
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How many market-years were included in the data set constructed by Dimson, Marsh, and Staunton?
How many market-years were included in the data set constructed by Dimson, Marsh, and Staunton?
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What is a characteristic outcome associated with volatile markets?
What is a characteristic outcome associated with volatile markets?
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What was the Sharpe ratio range for the carry trade when considering the entire period up to 2012?
What was the Sharpe ratio range for the carry trade when considering the entire period up to 2012?
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During which periods did the carry trade yield high risk-adjusted returns?
During which periods did the carry trade yield high risk-adjusted returns?
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What factor accounted for only one-third of the returns during the interwar period for carry and momentum strategies?
What factor accounted for only one-third of the returns during the interwar period for carry and momentum strategies?
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How did the performance of momentum strategies in the 1920s compare to subsequent periods?
How did the performance of momentum strategies in the 1920s compare to subsequent periods?
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What is one major reason cited for the inconsistent performance of carry and momentum strategies?
What is one major reason cited for the inconsistent performance of carry and momentum strategies?
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What were the large losses incurred by both the carry and momentum strategies associated with?
What were the large losses incurred by both the carry and momentum strategies associated with?
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What was the primary focus of Doskov and Swinkels' research?
What was the primary focus of Doskov and Swinkels' research?
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What challenge is often faced in predicting financial returns on durable assets like real estate?
What challenge is often faced in predicting financial returns on durable assets like real estate?
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What trend occurred in the US financial sector between 1970 and 2007?
What trend occurred in the US financial sector between 1970 and 2007?
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What financial innovation allowed US consumers to transform their housing assets?
What financial innovation allowed US consumers to transform their housing assets?
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Which group of borrowers faced significant risks due to variable interest rate loans?
Which group of borrowers faced significant risks due to variable interest rate loans?
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What misleading belief did many individuals hold regarding the stability of the US financial system?
What misleading belief did many individuals hold regarding the stability of the US financial system?
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What was one consequence of the run-up in housing prices exceeding 100% in five years?
What was one consequence of the run-up in housing prices exceeding 100% in five years?
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Which of the following was NOT identified as a strength of the US financial system?
Which of the following was NOT identified as a strength of the US financial system?
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What was a significant contributing factor to the challenges faced by subprime borrowers?
What was a significant contributing factor to the challenges faced by subprime borrowers?
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What effect did the attempts to maintain economic growth have in early 2008?
What effect did the attempts to maintain economic growth have in early 2008?
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What is the primary indicator used to measure a country's vulnerability as a foreign borrower?
What is the primary indicator used to measure a country's vulnerability as a foreign borrower?
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At what external debt to GNP level do risks of a credit event begin to increase significantly for emerging markets?
At what external debt to GNP level do risks of a credit event begin to increase significantly for emerging markets?
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Which percentage of observations in countries with a sound credit history is below 30% external debt to GNP?
Which percentage of observations in countries with a sound credit history is below 30% external debt to GNP?
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How is the proxy for default risk constructed using the Institutional Investor ratings?
How is the proxy for default risk constructed using the Institutional Investor ratings?
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What was a significant change in the nature of external debt in emerging markets before a crisis?
What was a significant change in the nature of external debt in emerging markets before a crisis?
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For countries with a tarnished credit history, what external debt to GNP level captures the majority of observations?
For countries with a tarnished credit history, what external debt to GNP level captures the majority of observations?
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What historical period saw significant instability in exchange rates that had not been seen again for nearly a century?
What historical period saw significant instability in exchange rates that had not been seen again for nearly a century?
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Which factor does NOT contribute to measuring debt intolerance?
Which factor does NOT contribute to measuring debt intolerance?
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What is a primary consequence of countries experiencing sustained high inflation?
What is a primary consequence of countries experiencing sustained high inflation?
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What do Institutional Investor ratings range from, in terms of default likelihood?
What do Institutional Investor ratings range from, in terms of default likelihood?
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What does the term 'liability dollarization' refer to?
What does the term 'liability dollarization' refer to?
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Why is dedollarization considered particularly challenging?
Why is dedollarization considered particularly challenging?
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What does hysteresis refer to in the context of a country's dollarization?
What does hysteresis refer to in the context of a country's dollarization?
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What has been a notable outcome after periods of elevated inflation regarding dollarization levels?
What has been a notable outcome after periods of elevated inflation regarding dollarization levels?
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What is the main aim of disinflation policy after high inflation?
What is the main aim of disinflation policy after high inflation?
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Which exchange rate crises occurred in the late 20th century?
Which exchange rate crises occurred in the late 20th century?
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What is the primary intuition that time-series analysis borrows from cross-sectional analysis?
What is the primary intuition that time-series analysis borrows from cross-sectional analysis?
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Which external factors contribute to a decline in required equity market returns?
Which external factors contribute to a decline in required equity market returns?
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What type of indicators are considered the most reliable for predicting market conditions over longer horizons?
What type of indicators are considered the most reliable for predicting market conditions over longer horizons?
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Which of the following is true regarding momentum and value signals?
Which of the following is true regarding momentum and value signals?
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What is a significant problem associated with the use of in-sample data for forecasting?
What is a significant problem associated with the use of in-sample data for forecasting?
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What is a common feature of the predictors over short horizons?
What is a common feature of the predictors over short horizons?
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What does the Inverse Shiller P/E ratio primarily forecast?
What does the Inverse Shiller P/E ratio primarily forecast?
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Which statement accurately describes the usefulness of tactical indicators for near-term market timing?
Which statement accurately describes the usefulness of tactical indicators for near-term market timing?
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Study Notes
Financial Market History (1900-2016)
- Cumulative real total returns include reinvested income, measured in local currency, adjusted for inflation. Reinvestment uses dividends, interests, or other income to buy more shares.
- Equities performed best long-term, followed by government bonds, and then Treasury bills. Resource-rich or New World countries had the best equity markets.
- In the US, an initial $1 investment in equities grew to $1271, $10 in bonds to $100, and $2.70 in bills to $27 over 116 years. The US was not the top performer globally for equities.
- UK equities saw an initial £1 investment grow to £445, £7 in bonds to £70, and £3.30 in bills to £33.
- Real annualized equity returns averaged 3-6% for most countries.
- Risky equities performed better than bonds or bills, but investors did not benefit from volatility.
Time-Variation of Expected Returns
- There's a shift from assuming constant expected returns to time-varying returns.
- Bond investors use current market yields to estimate long-term returns, adjusting for roll-downs and default risk.
- Equity investors often use long-run realized returns to estimate future returns, assuming constant expected returns over time.
- Historical average returns are a good estimate for long periods, mitigating sampling variation.
- Models are refined to include time-varying cash and bond yields, plus a constant equity premium. Historical data (1900-2015) show a 5% compound annual real return for global equities, 3.2% over global bonds and 4.2% over Treasury bills.
- The assumption of constant real returns forecasts a 5% future return.
Challenges of Timing the Market
- Practical market timing rules often have poor track records.
- Short-term predictability is limited, holding onto underperforming assets is difficult.
- No market-timing strategy universally outperforms buy-and-hold over time.
- Diversification, rather than tactical timing, often leads to better returns.
Time-Varying Returns and Market-Timing Opportunities
- Market-timing success is more art than science. Exploit historical data, theories, and market yields/valuations.
- Rational explanations of time-varying expected returns include time-varying volatility, risk aversion, rare-disaster risk. These are often cyclical, but there can be secular explanations like lower macro volatility or lower trading costs
- Irrational explanations for time-varying expected returns include changing sentiment and cycles of greed/fear and social interactions.
Valuation-Based Indicators
- Value and price momentum tend to be negatively correlated.
- Signals agree, like cheap markets with recent (positive) improvement, indicating a stronger signal.
- Longer-horizon value and yield indicators tend to offer better predictive ability than short-horizon momentum or macro indicators.
Currency Speculation Strategies (Carry, and Momentum)
- Carry: Borrowing low-interest rate currencies and investing in high-interest rate ones.
- Momentum: Borrowing from currencies with lower recent returns and investing in high-return currencies.
- Both are profitable strategies, some time, but performance is time-varying.
Historical Data Challenges and Biases
- Easy data bias: Scholars often overlook troubled periods and use readily available data sources. Secondary data is less clear in terms of methodology, which leads to bias
- Selection bias: Favoring large companies in statistics
- Survivorship bias: Only considering surviving companies ignores failures.
- Weighting bias: Indices may not represent the investable universe equally.
- Non-synchronous trading effects can introduce bias in analyses because different securities don't always trade at the same time
Domestic and External Default
- Serial defaults often occur with external or domestic public debt: these defaults can range from wholesale repudiation to strategic partial defaults via rescheduling.
- Debt intolerance is a syndrome that stems from weak institutions and political systems, leading struggling countries to engage in risky external borrowings.
- High debt-to-GNP ratios (often above 100%) increase the risk of default.
- A typical default involves a vicious cycle of market distrust, rising interest rates, and political resistance to repayment.
Other Information
- Inflation crises : typically chronic high-inflation episodes exceeding 15% annual for many years
- Banking crises : Systemic crises feature widespread bank runs, mergers/closures or government intervention. In milder crises, institutions show financial distress
- External Debt crisis : The failure of governments to meet debt obligations.
- Domestic debt crisis : Includes freezing bank deposits, forcing conversions to local currency and other forcible actions to deal with debts
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Description
Explore the historical performance of financial markets from 1900 to 2016. This quiz covers the long-term returns of equities, bonds, and Treasury bills, highlighting the differences in growth across various countries. Test your knowledge about investment returns and market performance over the last century.
