CFA Level I · CFA Level I Exam · Types of Financial Returns
Which statement best describes why analysts often prefer continuously compounded returns when modeling asset prices over multiple periods?
Continuously compounded returns are time-additive, so a multiperiod return is just the sum of the single-period log returns. This simplifies calculation and statistical modeling. They are not larger than discrete returns for positive values, and they do not remove risk.
- AThey are always larger than holding period returns
- BThey sum across periods, simplifying multiperiod return calculationsCorrect
- CThey remove the effect of risk from the return
Explanation
Because ln(P_T/P_0) equals the sum of the single-period log returns, multiperiod returns are found by simple addition, and the resulting statistics are easier to model. They are smaller, not larger, than discrete returns when those are positive, and they do not remove risk.
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