CFA Level I · CFA Level I Exam · Types of Financial Returns
Over a period, an investment's annual returns show considerable variability. Compared with the arithmetic mean return, the geometric mean return of that investment is most likely:
The geometric mean return is most likely lower than the arithmetic mean. Volatility reduces compound growth, and the gap widens as returns become more dispersed. The two are equal only when every periodic return is identical.
- Ahigher, because compounding adds to growth
- Blower, because volatility reduces compound growthCorrect
- Cequal, because both use the same returns
Explanation
The geometric mean is never above the arithmetic mean, and the gap widens as return dispersion rises. They are equal only when all returns are identical. Volatility drag therefore makes the geometric mean lower here.
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