Stocks, Bonds, Bills, and Inflation: Simulations of the Future (1976-2000)

Abstract

In the January issue of this Journal,I we presented year-by-year historical returns for common stocks, long-term U.S. government and corporate bonds, U.S. Treasury bills, and consumer goods (inflation) for the period 1926-74. In this paper, we present a simulation model to forecast probability distributions of returns for these assets. The model not only makes use of the historical data, but also employs the current U.S. government bond yield curve and integrates the two in a framework of capital market efficiency. Our forecasting procedure is inherently different from that used by most economists, financial analysts, long-range planners, etc. Whereas they use their expertise in an attempt to the market, our purpose is to uncover the market's forecast. In an efficient capital market, the consensus forecast removes the opportunity to outguess the market by eliminating overand underpricing of assets. To the extent that the simulation model portrays the market, its forecast can be thought of as a benchmark against which to compare other forecasts. In Part II we give a brief description of the historical data used in the simulations. In Part III, we present an overview of the entire model. The next two parts of the paper provide some justification for our techniques. Part IV examines the statistical characteristics of the historical data, while Part V explains the term structure characteristics of the yield curve. The formal model is presented in Part VI. The last two parts of the paper present the results. Part VII explains the forecast distributions over the period 19762000, while some of the major results are highlighted in Part VIII.