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Financial Aspects of the United States Pension System



Investing for the Short and the Long Term This PDF is a selection from an out-of-print volume from the National Bureau of Economic Research Volume Title: Financial Aspects of the United States Pension System Volume Author/Editor: Zvi Bodie and John B. Shoven, editors Volume Publisher: University of Chicago Press Volume ISBN: 0-226-06281-3 Volume URL: Publication Date: 1983 Chapter Title: Investing for the Short and the Long Term Chapter Author: Stanley Fischer Chapter URL: Chapter pages in book: (p. 153 - 176) 6 Investing for the Short and the Long Term Stanley Fischer The expected real monthly return on Treasury bills is serially correlated, by some estimates following a random walk.' Expected real returns on stocks have axlifferent dynamics. This means that the relative risk charac- teristics of stocks and bills differ depending on how long they are held. For example, suppose that the expected real returns on Treasury bills are highly serially correlated and that expected real returns on stocks are less serially correlated. It is known that the variance of unexpected real returns on stocks, looking ahead one month, is about one hundred times the variance of the unexpected real return on bills. Stocks are of course much riskier than bills in the short run of a month. Now consider an investor making a long-term portfolio decision to allocate his wealth between two mutual funds-a bill fund and a stock fund-with the proceeds being automatically reinvested in the fund in which they originate. Given the assumed serial correlation properties of asset returns, the longer the investment period, the less risky are stocks relative to bills. Three questions are taken up in this chapter: (1) How does the term structure of risk arising from differences in the dynamics of asset returns affect optimal investment behavior? (2) What is the evidence on the dynamics of returns on stocks

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