Suppose we want to estimate the future value of an investment based on its return history. This problem, at first glance, might seem pedestrian.
Yet it involves subtleties that confound many financial analysts. Some analysts argue that the best guide for estimating future value is the arithmetic average of past returns. Others claim that the geometric average provides a better estimate of future value. The correct answer depends on what it is about future value that we want to estimate. Let us proceed with a quick review of the arithmetic and geometric averages.