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The Expected Real Return to Equity

Missaka Warusawitharana

Board of Governors of the Federal Reserve System

March 18, 2013

Journal of Economic Dynamics and Control, Vol. 37, 2013
FEDS Working Paper No. 2011-14

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

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Date posted: April 17, 2011 ; Last revised: October 20, 2015

Suggested Citation

Warusawitharana, Missaka, The Expected Real Return to Equity (March 18, 2013). Journal of Economic Dynamics and Control, Vol. 37, 2013; FEDS Working Paper No. 2011-14. Available at SSRN: https://ssrn.com/abstract=1810056

Contact Information

Missaka Warusawitharana (Contact Author)
Board of Governors of the Federal Reserve System ( email )
20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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