Are Stocks Really Less Volatile in the Long Run?
56 Pages Posted: 26 May 2008 Last revised: 13 Dec 2011
Date Written: March 22, 2011
According to conventional wisdom, annualized volatility of stock returns is lower over long horizons than over short horizons, due to mean reversion induced by return predictability. In contrast, we find that stocks are substantially more volatile over long horizons from an investor's perspective. This perspective recognizes that parameters are uncertain, even with two centuries of data, and that observable predictors imperfectly deliver the conditional expected return. Mean reversion contributes strongly to reducing long-horizon variance, but it is more than offset by various uncertainties faced by the investor, especially uncertainty about the expected return. The same uncertainties reduce desired stock allocations of long-horizon investors contemplating target-date funds.
Keywords: stock, volatility, target-date funds, Bayesian, predictive system, predictive variance
JEL Classification: G12
Suggested Citation: Suggested Citation