How to predict the expected returns?

<p id="isPasted">Predicting expected returns involves using statistical and financial models to estimate the future performance of an investment based on historical data and current market conditions.&nbsp;</p><p>1. Core Calculation Methods</p><p>Probability Distribution: Expected return is the weighted average of all possible outcomes. You multiply each potential return by its probability of occurring and sum them up.</p><ul><li data-complete="true" data-hveid="CAEIBBAB" data-sae="" id="isPasted">Formula:&nbsp;<p>E(R)=∑(Return i×Probability i)</p></li><li data-hveid="CAEIBBAD" data-complete="true">Example: If there is a 50% chance of a 20% gain and a 50% chance of a 10% loss, the expected return is (5%) ((0.5 x 20+0.5 x -10)).</li></ul><p id="isPasted">Capital Asset Pricing Model (CAPM): This model estimates returns based on an asset's risk relative to the market.</p><ul><li>Formula:</li><li>(Expected Return=Risk-Free Rate+ beta x (Market Return-Risk-Free Rate))</li><li>Components: The Risk-Free Rate is often the yield on 3-month U.S. Treasury bills. Beta (\beta \) measures the asset's volatility compared to the broader market.</li><li id="isPasted">Portfolio Expected Return: For a collection of assets, the return is the weighted average of the individual expected returns based on the percentage of total capital invested in each. </li></ul><p>2. Key Data Sources</p><ul><li>Historical Performance: Analysts often use the last 10 years of an asset's performance to derive the probabilities for future returns.</li><li>Modern Portfolio Theory (MPT): This uses expected return alongside standard deviation (a proxy for risk) to determine if an investment's potential profit justifies its volatility.</li><li>Market Sentiment and Fundamental Analysis: Factors like a company’s Return on Investment (ROI) or specific knowledge about upcoming growth may lead investors to adjust their expectations beyond historical norms. </li></ul><p>3. Critical Limitations</p><ul><li>No Guarantees: Expected return is a prediction, not a guarantee. It does not account for unforeseen market shifts or "Black Swan" events.</li><li>Discrete vs. Continuous: Most basic models use discrete outcomes (specific percentages), whereas real-world returns are continuous and can take any value within a range. </li></ul>