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The expected real return to equity

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  • Warusawitharana, Missaka

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% . Furthermore, the analysis indicates that expected returns have declined by about 3 percentage points over the past 40 years. These results indicate that future returns to equity may be lower than past realized returns.

Suggested Citation

  • Warusawitharana, Missaka, 2013. "The expected real return to equity," Journal of Economic Dynamics and Control, Elsevier, vol. 37(9), pages 1929-1946.
  • Handle: RePEc:eee:dyncon:v:37:y:2013:i:9:p:1929-1946
    DOI: 10.1016/j.jedc.2013.04.003
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    References listed on IDEAS

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    Cited by:

    1. Urban Jermann, 2013. "A Production-Based Model for the Term Structure," NBER Working Papers 18774, National Bureau of Economic Research, Inc.
    2. Jermann, Urban J., 2013. "A production-based model for the term structure," Journal of Financial Economics, Elsevier, vol. 109(2), pages 293-306.

    More about this item

    Keywords

    Production-based asset pricing; Time-varying expected returns; Simulated method of moments; Aggregate earnings;

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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