Price Volatility A Historical Perspective

In trying to understand why we claim that the financial world has become more risky, you will find it useful to look back at the history of prices. Figure 23.1 provides a very long-term view of price levels for England. The price-level series shown begins in 1666 and runs through the mid-1980s. The remarkable fact revealed by this series is that for the first 250 years, prices changed very little (except in wartime). In contrast, in the last 30 or 40 years, prices have increased dramatically. As we saw in Chapter 12, the modern history of prices in the United States is similar.

As we also saw in Chapter 12, the rate of change in prices has slowed in recent years. The important lesson, however, is that even though the inflation rate is now relatively low in the United States, the uncertainty about the future rate of inflation remains. Beyond the

'This discussion is based on Charles W. Smithson, Managing Financial Risk: A Guide to Derivative Products, Financial Engineering, and Value Maximization, 3rd ed. (New York: The McGraw-Hill Companies, 1998).

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

VIII. Topics in Corporate Finance

23. Risk Management: An Introduction to Financial Engineering

© The McGraw-Hill Companies, 2002

CHAPTER 23 Risk Management: An Introduction to Financial Engineering

Changes in Five-Year Treasury Bond Rates: 1960-97

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