Stock Market Returns in the Long Run: Participating in the Real Economy

30 Pages Posted: 18 Jul 2001

See all articles by Roger G. Ibbotson

Roger G. Ibbotson

Yale School of Management; Zebra Capital Management, LLC

Peng Chen

Ibbotson Associates

Date Written: March 2002


We estimate the forward-looking long-term equity risk by extrapolating the way it participated in the real economy. We decompose the 1926-2000 historical equity returns into supply factors including inflation, earnings, dividends, price to earnings ratio, dividend payout ratio, book value, return on equity, and GDP per capita. There are several key findings: First, the growth in corporate productivity measured by earnings is in line with the growth of overall economic productivity. Second, P/E increases account for only a small portion of the total return of equity (1.25% of the total 10.70%). The bulk of the return is attributable to dividend payments and nominal earnings growth (including inflation and real earnings growth). Third, the increase in factor share of equity relative to the overall economy can be more than fully attributed to the increase in the P/E ratio. Fourth, there is a secular decline in the dividend yield and payout ratio, rendering dividend growth alone a poor measure of corporate profitability and future growth. Contrary to several recent studies, our supply side model forecast of the equity risk premium is only slightly lower than the pure historical return estimate. The long-term equity risk premium (relative to the long-term government bond yield) is estimated to be about 6% arithmetically, and 4% geometrically. Our estimate is in line with both the historical supply measures of the public corporations (i.e., earnings) and the overall economic productivity (GDP per capita).

Keywords: Equity Risk Premium

JEL Classification: G12

Suggested Citation

Ibbotson, Roger G. and Chen, Peng, Stock Market Returns in the Long Run: Participating in the Real Economy (March 2002). Available at SSRN: or

Roger G. Ibbotson (Contact Author)

Yale School of Management ( email )

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Zebra Capital Management, LLC ( email )

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Stamford, CT 06902
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Peng Chen

Ibbotson Associates ( email )

225 North Michigan Avenue
Suite 700
Chicago, IL 60601
United States
(312) 616-1620 (Phone)
(312) 616-0404 (Fax)