New facts in financeJohn H. CochraneIntroduction and summary economists view of the investment world was basedon three bedrocks:The last 15 years have seen a revolution in the way1. The CAPM is a good measure of risk and thusfinancial economists understand the investment world.a good explanation of the fact that some assets (stocks,We once thought that stock and bond returns wereportfolios, strategies, or mutual funds) earn higheressentially unpredictable. Now we recognize thataverage returns than others. The CAPM states thatstock and bond returns have a substantial predictableassets can only earn a high average return if theycomponent at long horizons. We once thought thathave a high beta, which measures the tendencythe capital asset pricing model (CAPM) provided aof the individual asset to move up or down with thegood description of why average returns on somemarket as a whole. Beta drives average returns becausestocks, portfolios, funds, or strategies were higher thanbeta measures how much adding a bit of the asset toothers. Now we recognize that the average returns ofa diversified portfolio increases the volatility of themany investment opportunities cannot be explainedportfolio. Investors care about portfolio returns, notby the CAPM, and multifactor models are used inabout the behavior of specific assets.its place. We once thought that long-term interest2. Returns are unpredictable, like a coin flip. Thisrates reflected ...
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