Risk , Return and
Portfolio Allocation.
Why Stocks Are less Risky Than
Bonds In Long Run?
HAFIDA LAZERGUI 148097
OLASHORE OLAIDE AZEEZAT. 147930
LAURA
Outline:
 Introduction
 Measuring risk and return
 Risk and holding period
 Standard measures of risk
 Varying correlation between stocks and bond returns
 Efficient frontier
 Conclusion
Introduction?
 Are bonds always safer than stocks ?
 Reasons:
 Payment priority.
 Long term and short term risk.
Measuring risk and return:
 Risk, return and correlation between assets.
 Affect of Inflation.
RISK AND HOLDING PERIOD
WHAT ABOUT TIPS?
Real Yield on 10-Year Treasury Inflation-Protected Securities (TIPS) 1997–2012
PERCENTAGE OF TIMES THAT STOCK OUTPERFORM BOND AND
BILLS
Holding Period
Stocks
Outperform
Time Period
Stocks
Outperform
Bonds
T-Bills
1 Year
1802–2012
1871–2012
58.8
61.3
62.1
66.9
2 Year
1802–2012
1871–2012
60.5
64.1
62.9
70.4
3 Year
1802–2012
1871–2012
67.2
68.7
70.2
73.3
5 Year
1802–2012
1871–2012
67.6
69.0
68.6
74.6
10 Year
1802–2012
1871–2012
72.3
78.2
73.3
83.8
20 Year
1802–2012
1871–2012
83.9
95.8
87.5
99.3
30 Year
1802–2012
1871–2012
91.2
99.3
91.2
100.0
WHEN BONDS OUTPERFORM STOCKS IN LONGRUN?
 1862 (ONSET OF THE US CIVIL WAR).
 1981-2011

Interest rate on 10 years bond: 16%

As interest rate fall: bondholders benefitted.

Resulted in

7.8%
return of 7.8 %real return(from 1981-2011).
1% greater than average stock historical return
Double average of historical bond return
3 times than average return of past 75 years.

By 2012 interest rate decreased .
Bond nominal yield 2%

Only way to generate that return again if CPI dropped by 6%.
STANDARD MEASURE OF RISK
• Standard deviation is used by investors to measure risk.
• Standard deviation is used to measure the volatility of a stock
• Although the standard deviation of stock return is higher than bond
return over short term holding periods
• Mean aversion of bond return is a characteristics of hyper inflation
where price changes at an accelerating rate rendering paper asset
worthless although mean aversion is also present in moderate
inflation which has impacted the US and other developed
economies.
Holding Periods: Historical Data and Random Walk
Hypothesis 1802–2012
Varying correlation between stock and
bond returns
 Even though the returns on bonds fall short of that on stocks, bonds may still serve to diversify a portfolio
and lower overall risk. The diversifying strength of an asset is measured by the correlation coefficient.
The correlation coefficient ranges between –1 and +1 and measures the co-movement between an asset’s
return and the return of the rest of the portfolio. The lower the correlation coefficient, the better the asset
serves as a portfolio diversifier. Assets with near-zero or especially negative correlations are particularly
good diversifiers. As the correlation coefficient between the asset and portfolio returns increases, the
diversifying quality of the asset decline.
 Slightly positive correlation (1926-1965).
 High positive correlation (1966-1997).
 NEGATIVE CORRELATION COEFFICIENT IN (1998-2012).
 the early part of that period, the world markets were roiled by economic and currency upheavals in Asia,
the deflationary economy in Japan, and then the terrorist events of September 11. Later the 2008 financial
crisis stoked fears of the 1930s, when deflation ruled and government bonds were the only appreciating
asset. These events led to the U.S. government bond market becoming once again a safe haven for those
investors fearing more economic turmoil and lower stock prices.
VARYING CORRELATION BETWEEN STOCK AND
BOND RETURNS
Efficient frontiers
Is a modern portfolio theory describes how investors may
alter the risk and return of a portfolio by changing the mix
between assets
Risk-Return Tradeoffs (Efficient Frontiers) for Stocks and Bonds Over Various Holding
Period 1802–2012
 the allocation that achieves the minimum risk is a function of
the investor’s holding period.
 Holding period has never been considered in standard
portfolio theory because modern portfolio theory was
established when majority academic professions supported the
random walk theory of prices
 When the prices are random walk, the risk over any holding
period is a simple function of the risk over a single period, so
that the relative risk of different asset classes does not depend
on the holding period
 This means the efficient frontier remains unaffected by the
time period and asset allocation does not depend on the
investment horizon of the investor
conclusion
In the short run stocks are riskier than fixed income
assets
In the long run, history has shown that stocks are
actually safer than bonds for long term investors
whose goal is to preserve the purchasing power of
their wealth
Historical data shows that we can be more certain of
the purchasing power of a diversified portfolio of
common stocks 30years from now than purchasing a
power principal on a 30 year US treasuary bond