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Long-Run Stock Returns: Participating in the Real Economy

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  • Roger G. Ibbotson

    () (Yale University, School of Management)

  • Peng Chen

    () (Ibbotson Associates)

Abstract

In 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.

Suggested Citation

  • Roger G. Ibbotson & Peng Chen, 2003. "Long-Run Stock Returns: Participating in the Real Economy," Yale School of Management Working Papers ysm354, Yale School of Management.
  • Handle: RePEc:ysm:somwrk:ysm354
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    Cited by:

    1. Fernandez, Pablo & Aguirreamalloa, Javier & Liechtenstein, Heinrich, 2009. "The equity premium puzzle: High required equity premium, undervaluation and self fulfilling prophecy," IESE Research Papers D/821, IESE Business School.
    2. Yacine Aït-Sahalia & Michael W. Brandt, 2008. "Consumption and Portfolio Choice with Option-Implied State Prices," NBER Working Papers 13854, National Bureau of Economic Research, Inc.
    3. Satyajit Chatterjee & Burcu Eyigungor, 2015. "A Quantitative Analysis of the US Housing and Mortgage Markets and the Foreclosure Crisis," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 18(2), pages 165-184, April.
    4. 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.
    5. William Goetzmann & Roger Ibbotson, 2005. "History and the Equity Risk Premium," Yale School of Management Working Papers ysm448, Yale School of Management.
    6. van Ewijk, Casper & de Groot, Henri L.F. & Santing, A.J. (Coos), 2012. "A meta-analysis of the equity premium," Journal of Empirical Finance, Elsevier, vol. 19(5), pages 819-830.
    7. Claude B. Erb & Campbell R. Harvey, 2013. "The Golden Dilemma," NBER Working Papers 18706, National Bureau of Economic Research, Inc.
    8. Eduardo Walker, 2016. "Cost of Capital in Emerging Markets: Bridging Gaps between Theory and Practice," Latin American Journal of Economics-formerly Cuadernos de Economía, Instituto de Economía. Pontificia Universidad Católica de Chile., vol. 53(1), pages 111-147, December.
    9. repec:eee:jfinec:v:125:y:2017:i:3:p:589-609 is not listed on IDEAS
    10. 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.
    11. Hachmeister, Dirk & Ruthardt, Frederik & Autenrieth, Matthias, 2014. "Marktrisikoprämien am deutschen Kapitalmarkt: Ermittlung, Simulation und Vergleich historischer und angebotsseitiger Marktrisikoprämien," Hohenheimer Schriften: Rechnungswesen - Steuern - Wirtschaftsprüfung 2014-01, University of Hohenheim, Department of Business Administration.
    12. Michael Wegener & Göran Kauermann, 2008. "Examining heterogeneity in implied equity risk premium using penalized splines," AStA Advances in Statistical Analysis, Springer;German Statistical Society, vol. 92(1), pages 35-56, February.
    13. Ari Levine & Yao Hua Ooi & Matthew Richardson, 2016. "Commodities for the Long Run," NBER Working Papers 22793, National Bureau of Economic Research, Inc.
    14. Rochon, Mathieu & Desrosiers, Stéphanie & L’Her, Jean-François, 2004. "Révision à la baisse de la prime sur les actions au Canada," L'Actualité Economique, Société Canadienne de Science Economique, vol. 80(1), pages 137-170, Mars.
    15. Christophe Faugere & Julian Van Erlach, 2003. "The Equity Premium: Explained by GDP Growth and Consistent with Portfolio Insurance," Finance 0311004, EconWPA.
    16. 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.
    17. Fernandez, Pablo, 2005. "La prima de riesgo del mercado (market risk premium)," IESE Research Papers D/585, IESE Business School.
    18. repec:rss:jnljef:v2i2p4 is not listed on IDEAS
    19. Fernandez, Pablo, 2004. "Market risk premium: Required, historical and expected," IESE Research Papers D/574, IESE Business School.
    20. Hachmeister, Dirk & Puchstein, Kerstin & Seidler, Patrick, 2016. "Die Marktrisikoprämie des DAX nach dem Dividenden- und Gewinnwachstumsmodell von Fama/French (2002)," Hohenheimer Schriften: Rechnungswesen - Steuern - Wirtschaftsprüfung 2016-01, University of Hohenheim, Department of Business Administration.
    21. Barbara Sveva Magnanelli & Elisa Raoli & Agnese Sacchi, 2016. "Key Factors for Success of Social Enterprises in Italy: Analysis of Financial and Operating Performance," Review of Economics & Finance, Better Advances Press, Canada, vol. 6, pages 43-60, February.

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    Keywords

    Portfolio Management; Asset Allocation;

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