The Expected Real Return to Equity
Federal Reserve Board - Board of Governors
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, G12Accepted Paper Series
Date posted: April 17, 2011 ; Last revised: December 19, 2013
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