The Expected Real Return to Equity

39 Pages Posted: 17 Apr 2011 Last revised: 20 Oct 2015

Missaka Warusawitharana

Board of Governors of the Federal Reserve System

Multiple version iconThere are 2 versions of this paper

Date Written: March 18, 2013

Abstract

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.

Keywords: Production-based asset pricing, Time-varying expected returns, Simulated method of moments

JEL Classification: E44, G12

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

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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