The Expected Return on Risky Assets: International Long-run Evidence

Abstract

This paper studies long-run trends in the expected return on risky wealth and its relationship with the safe rate. We combine new data and time-varying return predictability regressions to estimate expected returns on two major risky asset classes – equity and housing – across 17 countries and 145 years. We show that the expected risky return has been in steady long-run decline, falling by more than one-third between 1870 and 2015. Much of this decline is driven by a fall in the risk premium – from 6% in 1870 to 3% in 1990 – which can in turn be traced back to secular declines in the price of risk and macro-financial volatility. We further show that movements in expected returns are largely unrelated to safe rates, and hence safe rates and risk premia are strongly negatively correlated. This suggests that relative supply and demand factors – such as safe asset shortages and investor risk appetite – play a key role in determining the prices of risky and safe assets in the economy.