Estimating Long-Term Expected Returns
41 Pages Posted: 10 Jul 2023
Date Written: June 28, 2023
Estimating long-term expected returns as accurately as possible is of critical importance. Researchers typically base their estimates on yield and growth, valuation, or a combined yield, growth, and valuation framework. We run a horse race of the abilities of different frameworks and input proxies within each framework to estimate 10- and 20-year out-of-sample returns over 140-year and more recent time periods. Our results indicate that several approaches strongly outperform estimates based on historical mean benchmark returns, with mean square error improvements exceeding 40%. Using these approaches in asset allocation decisions results in an improvement in Sharpe ratios of more than 50%.
Keywords: Long-Term Expected Returns, Asset Allocation
JEL Classification: G11, G12
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