Estimating Long-Term Expected Returns Article Swipe

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Sharpe ratio Econometrics Valuation (finance) Proxy (statistics) Economics Statistics Mathematics Financial economics Finance Portfolio

Rui Ma , Ben R. Marshall , Nhut H. Nguyen , Nuttawat Visaltanachoti ·

YOU? · · 2024 · Open Access · · DOI: https://doi.org/10.1080/0015198x.2024.2358737 · OA: W4399626159

Estimating long-term expected returns as accurately as possible is of critical importance. Researchers typically base their estimates on yield and growth, valuation, or a combined yield, growth, and valuation ("three-component") framework. We run a horse race of the abilities of different frameworks and input proxies within each framework to estimate 10- and 20-year out-of-sample returns. The three-component model based on the TRCAPE valuation proxy outperforms estimates based on historical mean benchmark returns, with mean square error improvements exceeding 30%. Using this approach in asset allocation decisions results in an improvement in Sharpe ratios of more than 50%.