Forecasting Average Returns
Over the 81-year period 1926-2006, the geometric average return for the large company stocks was 10.4 percent and the arithmetic average return was 12.3 percent.
Calculate average return forecasts for 1, 5, 10, and 25 years into the future.
In this case, we would use Blume's formula with values of T = 1, 5, 10, and 25 and N = 81:
R(T)=T-1/80 X10.4% +81-T/80 X12.3%
|
T
|
R(T )
|
|
1
|
12.30%
|
|
5
|
12.2
|
|
10
|
12.1
|
|
25
|
11.7
|
|
81
|
10.4
|
Notice that short-term forecasts are closer to the arithmetic average return and long term forecasts are closer to the geometric average return.