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Compound Returns

Authors Adam Farago
Erik Hjalmarsson
Publisher University of Gothenburg
Place of publication Gothenburg
Publication year 2019
Published at Centre for Finance
Department of Economics
Language en
Keywords Compound returns, Diversification, Long-run returns, Skewness
Subject categories Economics


We provide a theoretical basis for understanding the properties of compound re-turns. At long horizons, multiplicative compounding induces extreme positive skewness into individual stock returns, an effect primarily driven by single-period volatility. As a consequence, most individual stocks perform very poorly. However, holding just a few stocks (instead of a single one) greatly improves the long-run prospects of an investment strategy, indicating that missing out on the “lucky few” winner stocks is not a great concern. We show analytically how this somewhat counterintuitive result arises from an interaction between compounding, diversification, and rebalancing that has seemingly not been previously noted.

Page Manager: Webmaster|Last update: 9/11/2012

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