Stock Market Returns in the Long Run: Participating in the Real Economy
AbstractWe 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).
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Yale School of Management in its series Yale School of Management Working Papers with number ysm206.
Date of creation: 01 Jul 2001
Date of revision: 01 Apr 2002
Equity Risk Premium;
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- R. Mehra & E. Prescott, 2010.
"The equity premium: a puzzle,"
Levine's Working Paper Archive
1401, David K. Levine.
- Andrew Ang & Geert Bekaert, 2001. "Stock Return Predictability: Is it There?," NBER Working Papers 8207, National Bureau of Economic Research, Inc.
- John Y. Campbell & Robert J. Shiller, 2001.
"Valuation Ratios and the Long-run Stock Market Outlook: An Update,"
Cowles Foundation Discussion Papers
1295, Cowles Foundation for Research in Economics, Yale University.
- John Y. Campbell & Robert J. Shiller, 2001. "Valuation Ratios and the Long-Run Stock Market Outlook: An Update," NBER Working Papers 8221, National Bureau of Economic Research, Inc.
- Eugene F. Fama & Kenneth R. French, .
"Disappearing Dividends: Changing Firm Characteristics or Lower Propensity to Pay?.","
CRSP working papers
509, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
- Eugene F. Fama & Kenneth R. French, 2001. "Disappearing Dividends: Changing Firm Characteristics Or Lower Propensity To Pay?," Journal of Applied Corporate Finance, Morgan Stanley, vol. 14(1), pages 67-79.
- Fama, Eugene F. & French, Kenneth R., 2001. "Disappearing dividends: changing firm characteristics or lower propensity to pay?," Journal of Financial Economics, Elsevier, vol. 60(1), pages 3-43, April.
- Merton H. Miller & Franco Modigliani, 1961. "Dividend Policy, Growth, and the Valuation of Shares," The Journal of Business, University of Chicago Press, vol. 34, pages 411.
- George M. Constantinides, 2002.
"Rational Asset Prices,"
Journal of Finance,
American Finance Association, vol. 57(4), pages 1567-1591, 08.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().
If references are entirely missing, you can add them using this form.