The expected real return to equity

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.     

Corporate asset purchases and sales: Theory and evidence

Purchases and sales of operating assets by firms generated $162 billion for shareholders over the past 20 years. This contrasts sharply with the evidence on mergers. This paper characterizes the behavior of value-maximizing firms, which could grow organically, purchase existing assets, or sell assets. The approach yields an endogenous selection model that links asset purchases and sales to fundamental properties of the firm. Empirical tests confirm the predictions of the model. In particular, return on assets and size strongly predict when firms purchase or sell assets, and the transaction size covaries with the value of capital employed by the firm. These findings indicate that corporate asset purchases and sales are consistent with efficient investment decisions.     

Predictable returns and asset allocation: Should a skeptical investor time the market?

We investigate optimal portfolio choice for an investor who is skeptical about the degree to which excess returns are predictable. Skepticism is modeled as an informative prior over the R²$R^2$ of the predictive regression. We find that the evidence is sufficient to convince even an investor with a highly skeptical prior to vary his portfolio on the basis of the dividend-price ratio and the yield spread. The resulting weights are less volatile and deliver superior out-of-sample performance as compared to the weights implied by an entirely model-based or data-based view.