Prague Economic Papers 2016, 25(3):335-353 | DOI: 10.18267/j.pep.563

Measuring Yields: Arithmetic, Geometric and Horizon-Consistent Average

Michal Dvořák
Faculty of Finance and Accounting, University of Economics, Prague, Department of Monetary Theory and Policy, and Czech National Bank, Czech Republic (michal@michaldvorak.eu).

The choice of averaging method has considerable impact on the average yield of a financial variable. Usually, geometric average is preferred, though dissenting opinions exist. Here it is shown that the problem has a consistent solution, which is called the horizon-consistent average. It is shown why geometric and arithmetic average calculations are almost always biased. When using company valuation's most common SP500 dataset by Ibbotson Associates for 1928-2012 and the recommended 10-year forecasting horizon, consistent with the 10-year government securities in a CAPM model, the arithmetic average is severely flawed. On the other hand, the geometric average for similar horizons does not deviate much from the horizon-consistent average.

Klíčová slova: yield, risk premium, historical yield, geometric average, arithmetic average
JEL classification: G1, G32

Zveřejněno: 1. leden 2016  Zobrazit citaci

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Dvořák, M. (2016). Measuring Yields: Arithmetic, Geometric and Horizon-Consistent Average. Prague Economic Papers, 25(3), 335-353. doi: 10.18267/j.pep.563
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