Long-Run Stock Returns: Participating in the Real Economy
AbstractIn the study reported here, we estimated the forward-looking long-term equity risk premium by extrapolating the way it has participated in the real economy. We decomposed the 1926–2000 historical equity returns into supply factors-inflation, earnings, dividends, the P/E, the dividend-payout ratio, book value, return on equity, and GDP per capita. Key findings are the following. 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. The bulk of the return is attributable to dividend payments and nominal earnings growth (including inflation and real earnings growth). Third, the increase in the equity market relative to economic productivity can be more than fully attributed to the increase in the P/E. Fourth, a secular decline has occurred in the dividend yield and payout ratio, rendering dividend growth alone a poor measure of corporate profitability and future growth. Our forecast of the equity risk premium is only slightly lower than the pure historical return estimate. We estimate the expected long-term equity risk premium (relative to the long-term government bond yield) to be about 6 percentage points arithmetically and 4 percentage points geometrically.
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 ysm354.
Date of creation: 04 Apr 2003
Date of revision:
Portfolio Management; Asset Allocation;
This paper has been announced in the following NEP Reports:
You can help add them by filling out this form.
CitEc Project, subscribe to its RSS feed for this item.
- Casper van Ewijk & C. Santing, 2010.
"A meta-analysis of the equity premium,"
CPB Discussion Paper
156, CPB Netherlands Bureau for Economic Policy Analysis.
- Christophe Faugere & Julian Van Erlach, 2003. "The Equity Premium: Explained by GDP Growth and Consistent with Portfolio Insurance," Finance 0311004, EconWPA.
- Satyajit Chatterjee & Burcu Eyigungor, 2011. "A quantitative analysis of the U.S. housing and mortgage markets and the foreclosure crisis," Working Papers 11-26, Federal Reserve Bank of Philadelphia.
- Ferreira, Miguel A. & Santa-Clara, Pedro, 2011. "Forecasting stock market returns: The sum of the parts is more than the whole," Journal of Financial Economics, Elsevier, vol. 100(3), pages 514-537, June.
- William Goetzmann & Roger Ibbotson, 2005. "History and the Equity Risk Premium," Yale School of Management Working Papers ysm448, Yale School of Management.
- Fernandez, Pablo, 2004. "Market risk premium: Required, historical and expected," IESE Research Papers D/574, IESE Business School.
- Christophe, Faugere, 2003. "A Required Yield Theory of Stock Market Valuation and Treasury Yield Determination," MPRA Paper 15579, University Library of Munich, Germany, revised 04 Jun 2009.
- Richard W. Kopcke & Matthew S. Rutledge, 2004. "Stock prices and the equity premium during the recent bull and bear markets," New England Economic Review, Federal Reserve Bank of Boston, pages 63-85.
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.