How To Study Capital Market History

A recent CFA Institute Magazine article asked the formidable question “Should financial history matter to investors?” [1] We unquestionably agree with the article’s survey results, which found that “when asked about the importance of economic and financial history to their success as investment professionals…” an overwhelming majority (96%) answered that it was either very or somewhat important.” [2]

However, the same article found that “some may not know how to use this knowledge to make better investment decisions (or, at the very least avoid poor ones)” [3] Hence, the objective of this article is to illustrate how the study of capital market history can provide investors with “helpful guidance on how historical perspectives can be incorporated into investment decision-making processes.” [4]

We have the following key takeaways for investors studying capital market history:

1. Start with the hypothesis being tested
2. Always visually inspect the data
3. Analyze the entire distribution
4. Calculation frequency matters?” [5]

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1,2,3,4 – “Should Financial History Matter to Investors?” by Desi Allevato, (Sept/Oct 2015), CFA Institute Magazine, page 17.
5 – Frequency refers to the periodicity (i.e. intra-day, daily, weekly, monthly, yearly) of the data and how it is used in the calculation. For example, the risk of an asset class, which is typically described as the standard deviation of the returns of the asset class, could be calculated using daily, monthly, quarterly or yearly return data measurement. As discussed later in this article, the frequency employed in this calculation matters for different frequencies can result in significantly different results. This is discussed in more detail in Short Horizon Inputs and Long Horizon Portfolio Choice by William N. Goetzmann and Franklin R. Edwards, The Journal of Portfolio Management, (Summer 1994), pages 76- 81. While it is beyond the scope of this paper to discuss the inputs for portfolio optimization, the ultimate discussion with solutions for handling portfolio optimization can be found in Efficient Asset Management: A Practical Guide to Stock Portfolio Optimization and Asset Allocation, by Richard Michaud and Robert Michaud, Oxford University Press; 2 edition (March 3, 2008), 144 pages.