Source: © Stocks, Bonds, Bills, and Inflation 2001 Yearbook™, Ibbotson Associates, Inc., Chicago (annually updates work by Roger G. Ibbotson and Rex A. Sinquefield). All rights reserved.

how predictably the Treasury bills (Figure 12.7) behaved compared to the small stocks (Figure 12.6).

The returns shown in these bar graphs are sometimes very large. Looking at the graphs, for example, we see that the largest single-year return is a remarkable 142.87 percent for the small-cap stocks in 1933. In the same year, the large-company stocks "only" returned 52.94 percent. In contrast, the largest Treasury bill return was 15.21

Ross et al.: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition

V. Risk and Return

12. Some Lessons from Capital Market History

© The McGraw-Hill Companies, 2002

Ross et al.: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition

V. Risk and Return

In Their Own Words

Roger Ibbotson on Capital Market History

The markets are the most carefully documented human phenomena in history. Every day, approximately 2,000 NYSE stocks are traded, and at least 6,000 more stocks are traded on other exchanges and in over-the-counter markets. Bonds, commodities, futures, and options also provide a wealth of data. These data daily fill more than a dozen pages of The Wall Street Journal (and numerous other newspapers), and these pages are only summaries of the day's transactions. A record actually exists of every transaction, providing not only a real-time database, but a historical record extending back, in many cases, more than a century.

The global market adds another dimension to this wealth of data. The Japanese stock market trades a billion shares on active days, and the London exchange reports trades on over 10,000 domestic and foreign issues a day.

The data generated by these transactions are quantifiable, quickly analyzed and disseminated, and made easily accessible by computer. Because of this, finance has increasingly come to resemble one of the exact sciences. The use of financial market data ranges from the simple, such as using the S&P 500 to measure the performance of a portfolio, to the incredibly complex. For example, only a quarter of a century ago, the bond market was the most staid province on Wall Street. Today, it attracts swarms of traders seeking to exploit arbitrage opportunities—small temporary mispricings—using real-time data and computers to analyze them.

Financial market data are the foundation for the extensive empirical understanding we now have of the financial markets. The following is a list of some of the principal findings of such research:

• Risky securities, such as stocks, have higher average returns than riskless securities such as Treasury bills.

• Stocks of small companies have higher average returns than those of larger companies.

• Long-term bonds have higher average yields and returns than short-term bonds.

• The cost of capital for a company, project, or division can be predicted using data from the markets.

Because phenomena in the financial markets are so well measured, finance is the most readily quantifiable branch of economics. Researchers are able to do more extensive empirical research than in any other economic field, and the research can be quickly translated into action in the marketplace.

Roger Ibbotson is professor in the practice of management at the Yale School of Management. He is the founder and president of Ibbotson Associates, a major supplier of financial databases to the financial services industry. An outstanding scholar, he is best known for his original estimates of the historical rates of return realized by investors in different markets and for his research on new issues.

percent, in 1981. For future reference, the actual year-to-year returns for the S&P 500, long-term government bonds, Treasury bills, and the CPI are shown in Table 12.1.

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