States of the World

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• All returns in real terms

• 100 States
  • obtained from discrete approximations of lognormal distributions
    • each state equally probable
    • taken from cumulative distribution at 0.005, 0.015,.. 0.995

• Properties of stock value relatives
  • 10 year horizon
  • all returns in real terms
  • riskless rate of interest
    • 2% per year
  • stock returns independent and identically distributed (IID)
  • lognormal distribution of stock market value relatives
  • one-year stock risk and return
    • expected return = 8%
    • standard deviation = 18%