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The expected real return to equity

  • Missaka Warusawitharana
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    The expected return to equity--typically measured as a historical average--is a key variable in the decision making of investors. A recent literature based on analysts forecasts and practitioner surveys finds estimates of expected returns that are sometimes much lower than historical averages. This study presents a novel method that estimates the expected return to equity using only observable data. The method builds on a present value relationship that links dividends, earnings, and investment to market values via expected returns. Given a model that captures this relationship, one can infer the expected return. Using this method, the estimated expected real return to equity ranges from 4 to 5.5 percent. Furthermore, the analysis indicates that expected returns have declined by about 2 percentage points over the past forty years. These results indicate that future returns to equity may be lower than past realized returns.

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    Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2011-14.

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    Date of creation: 2011
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    Handle: RePEc:fip:fedgfe:2011-14
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    22. Missaka Warusawitharana & Jessica A. Wachter, 2009. "What is the chance that the equity premium varies over time? evidence from predictive regressions," Finance and Economics Discussion Series 2009-26, Board of Governors of the Federal Reserve System (U.S.).
    23. Wachter, Jessica A. & Warusawitharana, Missaka, 2015. "What is the chance that the equity premium varies over time? Evidence from regressions on the dividend-price ratio," Journal of Econometrics, Elsevier, vol. 186(1), pages 74-93.
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