The Expected Real Return to Equity
Board of Governors of the Federal Reserve System
March 18, 2013
Journal of Economic Dynamics and Control, Vol. 37, 2013
The expected return to equity — typically measured as a historical average — is a key variable in the decision making of investors. A recent literature uses analysts’ forecasts, investor surveys or present-value relationships and finds estimates of expected returns that are sometimes much lower than historical averages. This study extends the present-value approach to a dynamic optimizing framework. Given a model that captures this relationship, one can use data on dividends, earnings and valuations to infer the model-implied expected return. Using this method, the estimated expected real return to equity ranges from 4.9 to 5.6 percent. Furthermore, the analysis indicates that expected returns have declined by about 3 percentage points over the past forty years. These results indicate that future returns to equity may be lower than past realized returns.
Number of Pages in PDF File: 39
Keywords: Production-based asset pricing, Time-varying expected returns, Simulated method of moments
JEL Classification: E44, G12
Date posted: April 17, 2011 ; Last revised: December 19, 2013
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