Investment Theory and Risk Management, + Website

Estimating Returns

The total return on an investment in any security is the percentage change in the value of the asset including dividends over a specific interval of time. Assuming asset value is captured in the market price P and dividends by d, then the one period total return, r₁, is equal to percent, in which the subscripts index time. For simplicity, we will ignore dividends, which gives us the price return, which, in decimal form, is equal to . Thus, is the gross return (the return plus the initial one-dollar outlay in the security) on the investment for one period, and is the net return; it is the return on a $1 investment. We can geometrically link returns to get the time equivalent of a longer-term investment. For example, suppose that the period under study is one month and that is therefore the one-month return. We can annualize this return by assuming the investment returns this amount in each month. Compounding this for one year is a product yielding the amount:

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