Estimates of the rate of return on a security based on the historical arithmetic average will probably tend to ________ the expected return for the long-term and estimates using the historical geometric average will probably tend to ________ the expected return for the short-term.
A) overestimate; overestimate
B) overestimate; underestimate
C) underestimate; overestimate
D) underestimate; underestimate
E) accurately estimate; accurately estimate

Question

Quizplus · Accepted Answer

The historical arithmetic average tends to overestimate the expected return for the long-term because it does not account for the compounding of returns. The historical geometric average, which does account for compounding, tends to underestimate the expected return for the short-term because it reflects the compound growth rate over the period, which is typically lower than the arithmetic average for short periods.

Estimates of the Rate of Return on a Security Based