Lesson 1 of 7 · 13 min

Asset classes: return, risk and other characteristics

Over long periods, asset classes with more risk have earned more return, but mean and variance alone miss skewness, fat tails and trading costs.

In short

Historical return is what was earned; expected return is what investors anticipate. Historical means are often used as estimates of expected returns, with caution.
Expected nominal return compounds three parts: $1 + E(R) = (1 + r_{rF})[1 + E(\pi)][1 + E(RP)]$ .
Long-run ranking by both risk and return: small-company stocks > large-company stocks > bonds > T-bills. This positive risk–return trade-off reflects risk-averse investors.
Real returns remove inflation and make periods comparable; the risk premium is the return above the risk-free rate.
Returns are not normal: equity returns show negative skewness and fat tails (kurtosis), risks a mean–variance view misses.
Liquidity drives trading costs through the bid–ask spread and price impact.

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