Historical Stock Quote Prices (4)

Historical Stock PricesIt sometimes seems like you can find anything you could possibly want to know on the internet. Furthermore, it is visible that share prices of the company A are more stable i.e. have lower standard deviation than those of company B. As we said, risk of an individual shock will be measured by the related standard deviation (in economy it is often called volatility). Prices of A shares are more stable than prices of B shares; related standard deviations are 0.0184 and 0.0267, respectively.

Also, it is evident that the prices are very negatively correlated (simplified explanation may be that the companies belong to the ‘opposite’ sectors: for example, company A produces ice creams whereas firm B produces umbrellas, and is currently the rainy season). In the first case, we assume that prices are very poorly correlated (say we deal with an ice cream company and a furniture factory), μa=0.1. In the second case, we assume that prices are highly positively correlated (considered companies, for example, are two ice cream companies), μb=1. This can occur when you ‘fortunately’ pick the right entry date and stumble across winning stocks when re-balancing.

Assuming that correlation coefficient between share prices of companies A and B is 0.1, calculated standard deviation and expected return are presented in the Table 2. Obtained pairs of standard deviation and expected return form the efficient frontier (see figure). As one can see on the figure, when the prices are 100% positively correlated (i.e. μb=1), then the efficient frontier is a line between points (σ1,r1) and (σ2,r2).

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Why preserve the myth: I think it is much more comforting for developed market investors to think of low interest rates as an unmitigated good, pushing up stock and bond prices, rather than as a depressing signal of future growth and low inflation (perhaps even deflation) in much of the developed world. One way to decompose the effects is to compute forward-looking expected returns on stocks, given stock prices today and expected cash flows from dividends and buybacks in the future to see how much of the stock price effect is fueled by interest rates and how much by cash flow changes.

Historical Stock Prices