New facts in finance

The last 15 years have seen a revolution in the way financial economists understand the investment world. We once thought that stock and bond returns were essentially unpredictable. Now we recognize that stock and bond returns have a substantial predictable component at long horizons. We once thought that the capital asset pricing model (CAPM) provided a good description of why average returns on some stocks, portfolios, funds, or strategies were higher than others. Now we recognize that the average returns of many investment opportunities cannot be explained by the CAPM, and "multifactor models" are used in its place. We once thought that long-term interest rates reflected expectations of future short-term rates and that interest rate differentials across countries reflected expectations of exchange rate depreciation. Now, we see time-varying risk premiums in bond and foreign exchange markets as well as in stock markets. We once thought that mutual fund average returns were well explained by the CAPM. Now, we see that funds can earn average returns not explained by the CAPM, that is, unrelated to market risks, by following a variety of investment "styles."