Triumph of the Optimists: 101 Years of Global Investment Returns

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Overview

Investors have too often extrapolated from recent experience. In the 1950s, who but the most rampant optimist would have dreamt that over the next fifty years the real return on equities would be 9% per year? Yet this is what happened in the U.S. stock market. The optimists triumphed. However, as Don Marquis observed, an optimist is someone who never had much experience. The authors of this book extend our experience across regions and across time. They present a comprehensive and consistent analysis of investment returns for equities, bonds, bills, currencies and inflation, spanning sixteen countries, from the end of the nineteenth century to the beginning of the twenty-first. This is achieved in a clear and simple way, with over 130 color diagrams that make comparison easy.

Crucially, the authors analyze total returns, including reinvested income. They show that some historical indexes overstate long-term performance because they are contaminated by survivorship bias and that long-term stock returns are in most countries seriously overestimated, due to a focus on periods that with hindsight are known to have been successful.

The book also provides the first comprehensive evidence on the long-term equity risk premium—the reward for bearing the risk of common stocks. The authors reveal whether the United States and United Kingdom have had unusually high stock market returns compared to other countries. The book covers the U.S., the U.K., Japan, France, Germany, Canada, Italy, Spain, Switzerland, Australia, the Netherlands, Sweden, Belgium, Ireland, Denmark, and South Africa.

Triumph of the Optimists is required reading for investment professionals, financial economists, and investors. It will be the definitive reference in the field and consulted for years to come.

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Editorial Reviews

Financial Times - Philip Coggan
At the very least, this [book] suggests that the recent blind adherence to the cult of the equity needs to be questioned and that the strategic weighting of bonds in institutional portfolios should be increased.
msn.com - Victor Niederhoffer and Laurel Kenner
A model of how investor research should be carried out. . . . Like most great books, Triumph of the Optimists has us saying 'Wow!' and 'Unbelievable!' with startling regularity. . . . This is a book that belongs on every investor's bookshelf.
Financial Times - Matthew Lynn
Connoisseurs of financial history will find plenty to enjoy in Triumph of the Optimists. . . . The evidence produced by Mr. Dimson and his colleagues is striking, [and]. . . these issues are more than just academic. . . . A provocative lesson.
Bloomberg Money - Ken Fisher
By far the most important investment book in years. . . .It is the best and most complete source of data yet available. . . . If you spend an hour with it and don't learn anything worth the price then you're truly lousy at learning about markets. . . Right now, buying this book makes more sense than buying stocks.
Time - Jason Zweig
A brilliant new book.
Active Trader Magazine
Our favorite book on global stock market performance. . . . [It] epitomizes outstanding investment research. . . . Unless intelligent life is discovered on another planet and a stock market is found to have been operating there for some centuries, it is unlikely that much new data can be brought to bear on the issue of long-run stock returns. Triumph of the Optimists may well be the last word on the subject for some time to come.
From the Publisher
"At the very least, this [book] suggests that the recent blind adherence to the cult of the equity needs to be questioned and that the strategic weighting of bonds in institutional portfolios should be increased."—Philip Coggan, Financial Times

"A model of how investor research should be carried out. . . . Like most great books, Triumph of the Optimists has us saying 'Wow!' and 'Unbelievable!' with startling regularity. . . . This is a book that belongs on every investor's bookshelf."—Victor Niederhoffer and Laurel Kenner, "Money" columnists, msn.com

"Connoisseurs of financial history will find plenty to enjoy in Triumph of the Optimists. . . . The evidence produced by Mr. Dimson and his colleagues is striking, [and]. . . these issues are more than just academic. . . . A provocative lesson."—Matthew Lynn, Financial Times

"By far the most important investment book in years. . . .It is the best and most complete source of data yet available. . . . If you spend an hour with it and don't learn anything worth the price then you're truly lousy at learning about markets. . . Right now, buying this book makes more sense than buying stocks."—Ken Fisher, Bloomberg Money

"A brilliant new book."—Jason Zweig, Time

"Our favorite book on global stock market performance. . . . [It] epitomizes outstanding investment research. . . . Unless intelligent life is discovered on another planet and a stock market is found to have been operating there for some centuries, it is unlikely that much new data can be brought to bear on the issue of long-run stock returns. Triumph of the Optimists may well be the last word on the subject for some time to come."Active Trader magazine

Financial Times
Connoisseurs of financial history will find plenty to enjoy in Triumph of the Optimists. . . . The evidence produced by Mr. Dimson and his colleagues is striking, [and]. . . these issues are more than just academic. . . . A provocative lesson.
— Matthew Lynn
msn.com
A model of how investor research should be carried out. . . . Like most great books, Triumph of the Optimists has us saying 'Wow!' and 'Unbelievable!' with startling regularity. . . . This is a book that belongs on every investor's bookshelf.
— Victor Niederhoffer and Laurel Kenner, "Money" columnists
Bloomberg Money
By far the most important investment book in years. . . .It is the best and most complete source of data yet available. . . . If you spend an hour with it and don't learn anything worth the price then you're truly lousy at learning about markets. . . Right now, buying this book makes more sense than buying stocks.
— Ken Fisher
Time
A brilliant new book.
— Jason Zweig
Active Trader magazine
Our favorite book on global stock market performance. . . . [It] epitomizes outstanding investment research. . . . Unless intelligent life is discovered on another planet and a stock market is found to have been operating there for some centuries, it is unlikely that much new data can be brought to bear on the issue of long-run stock returns. Triumph of the Optimists may well be the last word on the subject for some time to come.
Financial Times
Connoisseurs of financial history will find plenty to enjoy in Triumph of the Optimists. . . . The evidence produced by Mr. Dimson and his colleagues is striking, [and]. . . these issues are more than just academic. . . . A provocative lesson.
— Matthew Lynn
msn.com
A model of how investor research should be carried out. . . . Like most great books, Triumph of the Optimists has us saying 'Wow!' and 'Unbelievable!' with startling regularity. . . . This is a book that belongs on every investor's bookshelf.
— Victor Niederhoffer and Laurel Kenner, "Money" columnists
Active Trader magazine
Our favorite book on global stock market performance. . . . [It] epitomizes outstanding investment research. . . . Unless intelligent life is discovered on another planet and a stock market is found to have been operating there for some centuries, it is unlikely that much new data can be brought to bear on the issue of long-run stock returns. Triumph of the Optimists may well be the last word on the subject for some time to come.
Conrad DeAenlle
Over time, statistics look better than life. If an investor had bought $100 worth of American stocks at the market bottom in 1933, that modest portfolio would have grown to about $1 million by the end of 2000. Yet if long-term investing is so great, and everyone knows it, why aren't there more millionaires, or heirs of millionaires, walking around?
New York Times
Matthew Lynn
Connoisseurs of financial history will find plenty to enjoy in Triumph of the Optimists, a new book by three London Business School academics, Elroy Dimson, Paul Marsh and Mike Staunton. They will find a provocative lesson as well. Over the last century, equities have not produced anything like the returns investors have assumed. Nobody should expect great returns in the new century either. Shares as an investment have been consistently over-rated.
Financial Times
Economist
The equity premium (also known as the equity-risk premium) is a measure of the average annual return over and above riskless debt, such as government bonds, that shareholders expect to receive as compensation for holding risky shares. This risk is no illusion: shareholders are always the last to be paid, after other creditors get their cut. The authors conclude that all the world's stockmarkets offer strong evidence that riskier assets, on average, return more to investors.
Kenneth L. Fisher
Yes, the price is high, but their book offers much more than anyone has before. Educational and enjoyable, this book is a tremendous reference, providing detailed data on 101 years of returns from all over the globe. Just spend an hour with it and you're guaranteed to learn something worth the $99. The optimists in the title are those in the 1950s who believed stocks would have a 9% real return over the next half-century--and were right.
Forbes Magazine
Genevieve Cua
Set your sights lower on investment returns. That appears to be the consensus among more equity strategists these days, after two straight years of poor markets. Finally, three experts from the London Business School (LBS) have published a book and a yearbook that crunch through 102 years of market data. The research, sponsored by ABN Amro, may well become a major reference point for long-term historical and prospective rates of return, just as Ibbotson Associates' data is for the US market.
Business Times (Singapore)
Annette Sampson
The authors argue that going forward, the higher level of globalization will minimize the differences between different countries. While there will be differences over the shorter to medium term, they say the equity risk premium for shares that's investment-speak for the increased return you get from shares as opposed to a "safe'' asset like cash or bonds should be more uniform.
Sydney Morning Herald
M2 Best Books
A new book written by three academics from the London Business School provides an in-depth analysis of investment returns from the end of the 19th century to the beginning of the 21st.
Read More Show Less

Product Details

  • ISBN-13: 9780691091945
  • Publisher: Princeton University Press
  • Publication date: 1/14/2002
  • Series: Mathematical Finance Series
  • Edition description: New Edition
  • Pages: 320
  • Product dimensions: 8.60 (w) x 11.28 (h) x 1.26 (d)

Meet the Author

All three authors are at the London Business School. Elroy Dimson is Professor of Finance. Paul Marsh is Esmée Fairbairn Professor of Finance. Mike Staunton is Director of the London Share Price Database.

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Read an Excerpt

COPYRIGHT NOTICE: Published by Princeton University Press and copyrighted, © 2001, by Elroy Dimson, Paul Marsh and Mike Staunton. All rights reserved. No part of this book may be reproduced in any form by any electronic or mechanical means (including photocopying, recording, or information storage and retrieval) without permission in writing from the publisher, except for reading and browsing via the World Wide Web. Users are not permitted to mount this file on any network servers.

Chapter 1: Introduction and overview

The year 2001 was scarred by terrorism, and financial markets were beset by turmoil. As we look to the future, investors have more cause than ever to ask: Where are the markets heading? What returns can be expected from equities, bonds, and bills around the world? What are the long-term risks of stock and bond market investment? What are the likely long-term rewards?

Corporations also need answers to these questions to understand what returns their stockholders and bondholders require, and to ensure they raise and use capital to best effect. Similarly, these are crucial issues for governments, since market returns provide the yardsticks for judging the worth of public sector projects, and for raising and managing government debt. Regulators, too, need to know the cost of capital to set appropriate rates of return for regulated industries.

It is hard to form a judgment about future prospects, or about required or allowable rates of return, without making comparisons with the past. Recent market returns are widely publicized. But it has hitherto beendifficult to get a reliable impression of what investors have achieved over the long-term. Accurate historical records are available for the United States. However, the US economy has been remarkably successful. It would be dangerous for investors to extrapolate into the future from the US experience. We need to also look outside of the United States.

We also need to look long-term. Brief snippets of stock market history are not very helpful, unless our principal focus is on short-term volatility. For example, if we were interested in the volatility that can be anticipated over the next five years, the variability of the last 60 one-month returns or 260 one-week returns might be informative. But if we wish to say something about the expected return over the next five years, we cannot extract much information from the last five years. Further, the annual rate of return estimated from the last 60 months or 260 weeks is the same as the annual rate of return estimated over a single five-year interval. To estimate the expected return, we need a long run of data. We cannot improve estimates of the expected return by subdividing an interval into many short subperiods. While there are also benefits to looking at risk over the long haul, the need for long-term data is especially great when we are interested in expected returns.

To answer the key central questions about markets and investment prospects, we therefore need evidence that spans time and spans the world. The purpose of this book is to provide this evidence, and to point readers toward analysis that can help answer their questions.

1.1 Need for an international perspective

This book provides a comprehensive record of past investment returns around the world. It aims to help readers understand the historical record so that they can make informed judgments about the future. It does this by documenting the returns from equities, bonds, and bills, as well as inflation rates and currency movements, in four continents and sixteen countries, over the whole of the 101-year period from 1900–2000. We also have century-long evidence on the small-firm and value/growth phenomena. We have put significant effort into compiling complete financial market histories, so that we can present consistent and comparable records for different countries. But Triumph of the Optimists is about much more than just data, since it has description and analysis at its core.

There is an obvious need for a reliable and truly international dataset for the investment industry as it continues relentlessly toward full market globalization. One of the many changes taking place in the investment business is the increasing demand for locally sourced research placed in a global context. Another innovation is the growing number of truly global mandates being given to fund managers. Globalization may be a cliché, but for portfolio managers it is fast becoming a reality. Access to a properly constituted and rigorously maintained international database is a sine qua non for the start of any investment process.

The period since spring 2000 has come as a shock to those who had become used to the bull market conditions of previous years. The bursting of the technology bubble, the rapid decline in economic growth rates, especially in the United States, and the advent of international terrorism raised questions about what we can expect for the future. We assert in this book that the single most important variable for making investment decisions is the equity risk premium, and we argue that high long-term returns on equities, relative to bonds, are unlikely to persist. Even after the setbacks of 2000–01, it is necessary to justify the relatively high rating of today's stock markets in terms of a historically low forward-looking equity risk premium. For the investment strategist this raises the most fundamental question of all: Do investors realize that returns are likely to revert to more normal levels, or do current valuations embody exaggerated expectations based on an imperfect understanding of history?

Good data is the key to understanding history. With this as our guiding principle, assembling the data for this book was a major task. For the United Kingdom, ABN AMRO supported us in compiling an authoritative record of UK equity market performance over the last 101 years. We did this because we were not satisfied with the data that previously existed, and there was anyway no comprehensive record of equity returns extending back to 1900. To construct our UK indexes, we devoted intensive efforts to financial archaeology. This involved transcribing original source data from dusty newspaper archives and ancient reference books into our database. A resulting benefit is that we have not simply assembled an index, but we also have the underlying stock-by-stock data, so we can now study the performance of segments of the market, such as industry sectors and market-capitalization bands. We also compiled a series of UK government bond indexes especially for this study.

For the other fifteen countries covered in this book, we have linked together the best quality indexes and returns data available from previous studies and other sources, a number of which are previously unpublished, and some of which are still work in progress. In addition to the United Kingdom, we cover two North American markets, the United States and Canada; ten other European markets, namely, Belgium, Denmark, France, Germany, Ireland, Italy, The Netherlands, Spain, Sweden and Switzerland; two Asia-Pacific markets, Australia and Japan; and one African market, namely, South Africa. Taken together, these sixteen countries make up over 88 percent of today's world market capitalization, and were also dominant at the start of the twentieth century. We estimate that in 1900 these countries represented at least as high a proportion of the world equity market as they do today.

In each country we cover the same asset classes: equities, bonds, bills, inflation, and the local currency. We are therefore able to make comparisons between the investment performance of different asset classes, in different economic and political environments while focusing on whichever time period is of interest. We also have annual gross domestic product (GDP) data for all sixteen countries over the entire period.

Unlike most previous long-term studies of global markets, our investment returns all include reinvested income as well as capital gains. Our new indexes are more representative than those used in any previous study, and cover a longer time span for a larger number of countries. Furthermore, the common start date of 1900 facilitates cross-country comparisons. We can now set the US data alongside comparable length series for the same asset classes for fifteen other countries, and make international comparisons that help set the US experience in perspective.

Measuring what has happened in the past is only the starting point for assessing the future. Interpretation of the data and being able to apply it to a modern-day canvas are as important. Throughout this book, therefore, our emphasis is not simply on describing the past, but also on interpreting what has happened, with an eye to what it tells us about the future.

1.2 The historical record

Our story opens in the following chapter, not at the beginning but at the end of our 101-year period. We look in chapter 2 at world markets as they stand today—their overall size and significance and the split between markets and countries. Global league tables set in perspective the importance of the sixteen countries covered in this study. We look back to the beginning of our period to review what stock markets looked like 101 years ago, at the start of the twentieth century, and at how, and why, they had evolved since their origins several centuries before.

Using the detailed stock-by-stock data that we have assembled for the United Kingdom, together with comparable data for the United States, we provide some snapshots of how the corporate landscape has changed over the twentieth century. In particular, our analysis of industrial composition reveals some major contrasts—and some surprising similarities—between the structure of the US and UK equity markets today and 101 years ago. We also show how stock exchange concentration has increased in recent years, while showing that markets have several times in the past been even more concentrated than today.

In chapter 3, we begin by considering the guiding principles that underpin measures of long-term investment performance. Even with good index construction, an index is only as reliable as the underlying data and sample, so we also discuss the coverage of indexes, both across securities and over time. We highlight the dangers of survivorship and success bias. Taking the United Kingdom as an example, we show how these biases have in the past exaggerated the historical attractiveness of investing in common stocks.

Turning to the international evidence, when making comparisons across markets there has been a reliance on index series for countries that have not experienced a material break in trading. Even more marked, however, is the impact of initiating an index series after unrest, or wars, and their aftermath have been resolved. We show that this "easy data bias," the tendency by researchers and index compilers to limit their research and indexes to easily obtained data, has provided investors with a misleadingly favorable impression of long-term equity performance.

The remainder of the book is therefore devoted to a detailed examination of stocks, bonds, bills, inflation, and currencies over the period since 1900. Chapter 4 provides an overview of international capital market history, focusing on our 101-year study of the United States, the United Kingdom and fourteen other markets. We quantify the impact of inflation on the total return from US and UK equities, and then examine real and nominal stock market performance across our full sample of international capital markets. We show the extent to which rates of return on equities have been higher than the return on government bills and bonds, though this is by a smaller margin than many investors have perceived.

We report on the volatility of equity and bond returns, and show the extent to which diversification across stocks reduces the risk of a domestic equity portfolio. We examine how risk varies across asset classes and countries. We find that while equities were riskier than bonds, which in turn were riskier than bills, these risks were rewarded. Equities performed better than bonds in every single country, while bonds beat bills almost everywhere.

The next two chapters deal with the returns from investing in short-term deposits (treasury bills) and long-term bonds. Chapter 5 describes the historical record on interest rates and inflation. Chapter 6 presents the evidence on bond returns and bond maturity premia—the reward from investing in long- rather than short-term bonds. We compare bond maturity premia across different time periods and national markets. We also analyze inflation-indexed government bonds and corporate bonds for countries that present a sufficiently long history for these assets. In chapters 5 and 6, we see the twentieth century through the lens of the financial markets. The financial data reveals the turbulence of the past—inflation and hyperinflation, extreme periods when even bond and bill investors lost everything, deflation, and the Great Depression, as well as two world wars and their legacies.

For the international investor, currency movements matter since investment returns need to be converted from local currencies into the investor's reference currency. Exchange rate changes thus impact performance, and are critical for measuring and comparing the returns from different countries. In chapter 7, we report on the exchange rate fluctuations that were experienced by our sixteen countries over the course of the 101 years from 1900–2000.

Chapter 7 also examines the extent to which purchasing power parity has held over the long run. Purchasing power parity implies that goods and services will have a similar price experience in different countries, but this is a poor description of year-to-year foreign exchange fluctuations. Over the long run, however, we find that changing relative price levels do tend to be reflected in changes in exchange rates, and that real exchange rates are relatively stable. This means that when we compute the common-currency returns on equities and bonds across our sixteen countries, and compare these with the earlier rankings from chapter 4 based on the real, inflation-adjusted returns within each country, we find a very similar picture.

Chapter 8 focuses on international investment, addressing the question of how investors from around the world, including the United States, would have fared from foreign investment. In doing this, we recognize that international investors are concerned not just with the returns from investing abroad, but also the risks. We examine the impact of exchange risk, and the risk reduction benefits from international diversification.

We create benchmarks for assessing the risk and return from international diversification by constructing a sixteen-country, twentieth century world index for both equities and bonds. We find that investors in most countries would have been better off investing worldwide rather than restricting their portfolios to domestic securities. International diversification reduces risk because different countries' markets and currencies are less than perfectly correlated. We report the pairwise correlations between national market indexes, and find that correlations based on recent periods are higher than when based on long-term history. The potential gains from international diversification are thus lower than they once were.

Nevertheless, there are discernable and worthwhile gains from diversifying internationally. Despite this, investors in most countries still hold portfolios that are heavily weighted toward domestic assets. We document this "home bias" puzzle, and discuss the costs and impediments to international investment that existed at various stages during the twentieth century, some of which remain in place today.

1.3 Inside the markets

For some markets, we have access to the underlying security-level data that underpins the index series. Using this data, we can look in depth at stock market attributes within a national market. This is the focus of the next three chapters.

In chapter 9 we return to the equity markets to focus on two particular aspects of investment in stocks, namely, the effects of size and seasonality. Over the last twenty years, the small-firm premium, or the tendency for smaller companies to outperform larger ones, has become the best-documented stock market anomaly around the world. In this chapter, we review the international evidence, starting with the well-known record of smaller companies in the United States. We then draw comparisons with corresponding research for the United Kingdom, and extend to reviewing the relative performance of small companies around the world. A frustrating feature of the size effect is that soon after its discovery the size premium went into reverse, with smaller companies subsequently underperforming their larger counterparts. We show that this reversal was a worldwide phenomenon.

Chapter 9 also touches on stock market seasonality, briefly reviewing the calendar-related anomalies that have been noted in the world's stock markets. While a fuller analysis is beyond the scope of this book, we single out the January effect for closer attention. There are two reasons for this. First, of all the calendar anomalies, the January effect is the best known and most important. Second, it is closely intertwined with the size effect since in the United States, the entire historical outperformance of smaller stocks is attributable to their returns in January. Intriguingly, however, when we seek to replicate the US findings for the United Kingdom, we find no evidence of a size-based seasonal in January, or any other month.

In chapter 10 we turn to another aspect of equity investment: the performance of value and growth stocks. We confirm the superior long-term performance in the United States of value stocks, namely, those with a high dividend yield and/or a high ratio of book to market value of equity. Value stocks have performed markedly better than their growth-stock counterparts, that is, shares that sell at a low yield and/or a low book-to-market ratio.

The US evidence covers three-quarters of a century but the United States is hitherto the only country for which there is long-run data. We present new value and growth indexes for the United Kingdom, based on a comprehensive sample of companies and data that spans a century. The United Kingdom provides further support for the superior results, over the long haul, from following a value strategy. International evidence for other countries covers a shorter period but supports the claim that value investing has tended to provide higher returns in almost all countries that we consider in this book.

The above discussion highlights the importance of dividends, and these are discussed in chapter 11. This chapter shows the crucial contribution that dividends make to long-term stock market performance. We look at dividend growth over the last century in the United States, the United Kingdom and around the world, and draw comparisons with growth rates in national GDP. Real dividends have grown more slowly than per capita GDP in all countries, a fact that puts in context the debate about the likelihood of dividend growth outstripping GDP. We quantify the recent decline in dividend payments in the United States and the United Kingdom, and emphasize the need to consider the total payout as well as cash dividend payments.

1.4 The equity premium

Investment in equities over the twentieth century has proved rewarding, but has been accompanied by correspondingly greater risks. In chapter 12, we examine the historical rewards that investors have enjoyed for bearing this risk. We do this by comparing the return on equities with the return from risk free investments. When measured over a sufficiently long period, the difference between these two returns is called the equity risk premium.

In chapter 12, we provide evidence on the long-run magnitude of the equity risk premium, estimated relative to both bills and bonds. Our risk premia are lower than those that have been reported in previous studies of US and UK stock market performance. The differences arise from previous biases in index construction (for the United Kingdom), and (for both countries) from the use of a rather longer time frame, extending back to 1900.

The equity risk premium is a very important economic variable. An estimate of the premium is central to projecting future investment returns, calculating the cost of equity capital, valuing companies and stocks, appraising capital investment projects, and determining fair rates of return. All these applications need an estimate of the prospective risk premium, whereas the only premium we can measure is the historical premium. The prospective risk premium forms the subject of chapter 13.

Many people argue that the historical risk premium, if measured over a long enough time span, gives an unbiased estimate of the prospective premium. We review evidence that suggests that academic experts typically subscribe to this view, and that their own forecasts are heavily influenced by the historical record. The research conducted for this book, however, leads us to question whether the historical risk premium really does provides a reasonable estimate of the prospective premium. Our belief is that historical equity returns have almost certainly exceeded investors' ex ante risk premium requirements, and also that the required risk premium has itself fallen over time. We use evidence from historical dividend growth to back up these assertions, and to suggest an alternative, rather lower, estimate of the future risk premium.

The final two chapters in Part One of this book use our new international database to look toward the future. Chapter 14 explores the implications of our findings for investors. We examine the evidence that supports the thesis that stocks are a (relatively) safe investment over the long run. In the United States and the United Kingdom stocks have historically equalled or beaten risk free investment over holding periods of approximately twenty years or longer. We discover that this is not the usual pattern. For equity investors to have beaten bond investors, it would often have been necessary to have an investment horizon of forty years or more.

We discuss some of the investment implications of our findings. We emphasize how we should alter our judgments in the light of a reduced estimate for the future equity risk premium. There are strong inferences that can be drawn about the role for active management, the case for index funds, levels of management fees, tax management, asset allocation, international diversification, and strategies for exploiting anomalies and regularities. Chapter 14 summarizes the implications of our research for investors and investment institutions.

In chapter 15 we extend this discussion to the cost of capital and the impact of an attenuated equity premium on real investment decisions. We express a concern that companies may themselves be seeking too high a rate of return, and if so, that they run the risk of under-investing. We again explore a range of implications, with an accent on the valuation of shares and companies, and on corporate financing decisions. We conclude Part One of the book with chapter 16, which provides a summary of Triumph of the Optimists, and a review of conclusions based on our international dataset and on the analysis presented in this book.

1.5 Sixteen countries, one world

Part Two of the book commences with chapter 17, which provides an overview of the following sixteen chapters, each of which describes the individual database for a particular country, and presents a 101-year study of risk and return in that national market. We explain the common features of each country study, and how our results are presented. Readers who are interested in a particular country are urged to read this chapter first.

Chapters 18–33 provide highlights of the research results for each individual market, listed in successive chapters in alphabetical order. We explain our data sources and the specifics of the research methodology for the country in question. In each chapter we include a record of nominal and real (inflation adjusted) returns and of risk premia, estimated over a variety of recent and long-term intervals, and presented in both tabular and graphical formats.

Finally, in chapter 34, we bring together our results for individual countries by assembling a world index. This presents the performance of a sixteen-country portfolio, weighted by market capitalization (or, in the early decades, by relative GDP). As with the individual countries, we record returns and equity premia over various intervals. This index series is to date the most accurate estimate of the long-run total return, including reinvested dividends, from investing in stocks and bonds around the world.

A feature of our research is that we make extensive use of long-term rate-of-return studies undertaken by scholars in a variety of countries. These individuals are identified in the relevant chapters, and their contributions are listed among the references at the end of the book. The research effort that underpins our database therefore embodies many months and years spent by our contributors (and by us) in library vaults and archives. The reason for these efforts is the importance each researcher attaches to the markets we cover in this book. In the next chapter, we describe global financial markets, and put our sixteen countries in perspective on the world stage.

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Table of Contents

Preface xi

Part One: 101 years of global investment returns 1

Chapter 1 Introduction and overview 3
1.1 Need for an international perspective 3
1.2 The historical record 5
1.3 Inside the markets 7
1.4 The equity premium 8
1.5 Sixteen countries, one world 10

Chapter 2 World markets: today and yesterday 11
2.1 The world's stock markets today 11
2.2 The world's bond markets today 14
2.3 Why stock and bond markets matter 18
2.4 The world's markets yesterday 19
2.5 The US and UK stock markets: 1900 versus 2000 23
2.6 Industry composition: 1900 versus 2000 23
2.7 Stock market concentration 28
2.8 Summary 32

Chapter 3 Measuring long-term returns 34
3.1 Good indexes and bad 34
3.2 Index design: a case study 36
3.3 Dividends, coverage, and weightings 38
3.4 Easy-data bias in international indexes 40
3.5 Measuring inflation and fixed-income returns 43
3.6 Summary 44

Chapter 4 International capital market history 45
4.1 The US record 45
4.2 The UK record 48
4.3 Stock market returns around the world 50
4.4 Equities compared with bonds and bills 51
4.5 Investment risk and the distribution of annual returns 54
4.6 Risk, diversification, and market risk 56
4.7 Risk comparisons across asset classes and countries 59
4.8 Summary 61

Chapter 5 Inflation, interest rates, and bill returns 63
5.1 Inflation in the United States and the United Kingdom 63
5.2 Inflation around the world 65
5.3 US treasury bills and real interest rates 68
5.4 Real interest rates around the world 71
5.5 Summary 72

Chapter 6 Bond returns 74
6.1 US and UK bond returns 74
6.2 Bond returns around the world 79
6.3 Bond maturity premia 81
6.4 Inflation-indexed bonds and the real term premium 84
6.5 Corporate bonds and the default risk premium 87
6.6 Summary 89

Chapter 7 Exchange rates and common-currency returns 91
7.1 Long-run exchange rate behavior 91
7.2 The international monetary system 93
7.3 Long-run purchasing power parity 95
7.4 Deviations from purchasing power parity 96
7.5 Volatility of exchange rates 98
7.6 Common-currency returns on bonds and equities 100
7.7 Summary 103

Chapter 8 International investment 105
8.1 Local market versus currency risk 105
8.2 A twentieth century world index for equities and bonds 108
8.3 Ex post benefits from holding the world index 111
8.4 Correlations between countries 114
8.5 Prospective gains from international diversification 117
8.6 Home bias and constraints on international investment 120
8.7 Summary 123

Chapter 9 Size effects and seasonality in stock returns 124
9.1 The size effect in the United States 124
9.2 The size effect in the United Kingdom 126
9.3 The size effect around the world 129
9.4 The reversal of the size premium 131
9.5 Seasonality and size 135
9.6 Summary 138

Chapter 10 Value and growth in stock returns 139
10.1 Value versus growth in the United States 139
10.2 Value and growth investing in the United Kingdom 142
10.3 The international evidence 145
10.4 Summary 148

Chapter 11 Equity dividends 149
11.1 The impact of income 149
11.2 US and UK dividend growth 152
11.3 Dividend growth around the world 154
11.4 Dividend growth, GDP growth, and real equity returns 155
11.5 Dividend yields around the world and over time 157
11.6 Disappearing dividends 158
11.7 Summary 161

Chapter 12 The equity risk premium 163
12.1 US risk premia relative to bills 163
12.2 Worldwide risk premia relative to bills 166
12.3 US risk premia relative to bonds 169
12.4 Worldwide risk premia relative to bonds 171
12.5 Summary 173

Chapter 13 The prospective risk premium 176
13.1 Why the risk premium matters 177
13.2 How big should the risk premium be? 179
13.3 Measuring the premium 181
13.4 Arithmetic and geometric premia 183
13.5 The changing consensus 185
13.6 History as a guide to the future 188
13.7 Expectations of the risk premium 190
13.8 Summary 193

Chapter 14 Implications for investors 195
14.1 Market risk in the twenty-first century 195
14.2 Inferences from other markets 199
14.3 What does the future hold? 202
14.4 Implications for individual investors 204
14.5 Implications for investment institutions 207
14.6 Summary 209

Chapter 15 Implications for companies 211
15.1 The cost of capital 211
15.2 Corporate investment decisions 215
15.3 Corporate financing decisions 217
15.4 Summary 219

Chapter 16 Conclusion 220
16.1 Long-term returns 220
16.2 Key messages 222
16.3 Conclusion 224

Part Two: Sixteen countries, one world 225

Chapter 17 Our global database 227
Chapter 18 Australia 229
Chapter 19 Belgium 234
Chapter 20 Canada 239
Chapter 21 Denmark 244
Chapter 22 France 249
Chapter 23 Germany 254
Chapter 24 Ireland 259
Chapter 25 Italy 264
Chapter 26 Japan 269
Chapter 27 The Netherlands 274
Chapter 28 South Africa 279
Chapter 29 Spain 284
Chapter 30 Sweden 289
Chapter 31 Switzerland 294
Chapter 32 United Kingdom 299
Chapter 33 United States 306
Chapter 34 World 311

References 316
About the authors 331
Index 333

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Recipe

"This will become the definitive empirical basis for analysis of the world's capital markets over the twentieth century. It is an important work of scholarship; no one else has calculated the equity premium of a large number of countries over the long term. In doing so, the book contributes to the very lively debate on the magnitude of the equity premium and will make a splash."—William Goetzmann, Yale University

"Recent years have seen unprecedented public interest in the stock market, but there is a tendency for investors to concentrate on recent U.S. stock market performance. Progress in understanding financial markets requires a much longer timeframe and a global perspective. This book presents and analyzes data from many countries in a simple, standardized way that makes comparisons easy. It makes a number of extremely important points and goes well beyond simple summaries of average returns and historical volatilities to look at such issues as seasonality and industrial structure."—John Campbell, Harvard University

"No investor can afford to risk a penny in the markets without studying this book and absorbing its fascinating lessons. That advice applies whether you are professional or amateur, a youngster or hardened from experience, bold or conservative. This book is history at its most challenging and illuminating. The facts are astonishing, the presentation dazzling, the analysis brilliant, and the lessons profound."—Peter L. Bernstein, author of Capital Ideas and Against the Gods

"This is an important addition to the investment literature and will be widely used by both the academic and business community. To have the scope ofdata and analysis contained in this book available in one place represents a major contribution and improvement over what is now available."—Martin J. Gruber, New York University

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  • Anonymous

    Posted October 8, 2003

    Valuable Place in the Collection

    This is a fantastic book for the number lovers of the financial markets. It covers in depth research over 80% of the world's markets (by capitalization) and looks at key issues of inflation, currency exchange, bills, bonds, and company equity. It tells the historical performance through wars, depressions, and runaway hyperinflations. This book gets high praise for the data collection and analysis.

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