Long-term Government Bond Yields Research Articles

Stock Market Returns in the Long Run: Participating in the Real Economy

We estimate the forward-looking long-term equity risk by extrapolating the way it participated in the real economy. We decompose the 1926-2000 historical equity returns into supply factors including inflation, earnings, dividends, price to earnings ratio, dividend payout ratio, book value, return on equity, and GDP per capita. There are several key findings: 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 (1.25% of the total 10.70%). The bulk of the return is attributable to dividend payments and nominal earnings growth (including inflation and real earnings growth). Third, the increase in factor share of equity relative to the overall economy can be more than fully attributed to the increase in the P/E ratio. Fourth, there is a secular decline in the dividend yield and payout ratio, rendering dividend growth alone a poor measure of corporate profitability and future growth. Contrary to several recent studies, our supply side model forecast of the equity risk premium is only slightly lower than the pure historical return estimate. The long-term equity risk premium (relative to the long-term government bond yield) is estimated to be about 6% arithmetically, and 4% geometrically. Our estimate is in line with both the historical supply measures of the public corporations (i.e., earnings) and the overall economic productivity (GDP per capita).

A NEW MODEL FOR ESTIMATING RISK PREMIUMS (ALONG WITH SOME EVIDENCE OF THEIR DECLINE)

This article uses the Gordon growth model with a novel method for forecasting dividend growth rates to estimate the equity cost and associated risk premium for a sample of Canadian telecommunications companies. The results suggest that the Telco risk premium has declined significantly since the early 1980s. Moreover, this decline is accentuated when measured over long Canada yields, rather than over similarly taxed, longterm preferred yields.The findings of this study also suggest that the inverse relationship between utility risk premium and market interest rates reported by studies of U.S. utilities does not hold in Canada. If anything, the Telco risk premium has tended to vary directly with the level of market interest rates, with risk premium falling along with the general decline in rates. The main reason for these results seems to be the significant increase in interest rate risk, which has caused the long Canada yield to be a very poor proxy for the longterm, riskfree rate.One practical implication of this finding is that companies that estimate equity costs as a premium over longterm government bond yields are probably seriously overestimating the cost.

The fundamental determinants of interest rate differentials in the ERM

The paper analyses the sources of persistent interest rate differentials vis-à-vis Germany that have existed in Belgium, Denmark, France, Ireland, Italy, and the Netherlands. In a target zone system like the ERM, interest rate differentials mainly reflect devaluation expectations, which are measured here by raw 1-month Euromarket interest rate differentials, drift-adjusted 1-month differentials, and differentials in long-term government bond yields. The role of a large set of fundamental macroeconomic variables that may have affected these devaluation expectations is investigated within a vector autoregressive (VAR) setting, by means of Granger-causality tests, impulse-response functions and variance decompositions. We find no evidence that fundamentals are more relevant to drift-adjusted devaluation risk than for unadjusted interest rate differentials. A significant impact of inflation, budget deficits, and unemployment becomes evident for almost all ERM-participants.

The interest-rate management and sterilization hypotheses for the UK: under fixed exchange rates

This study uses the vector autoregressive (VAR) technique and Granger's definition of causality to examine the interest rate management and sterilization hypotheses of UK for the period 1955.I to 1974.IV. Our findings show that neither the long-term government bond yield nor long-term treasury bill rate of UK can be considered as a policy-determined variable, since each is subject to feedback from UK and US monetary and income variables. In regard to the sterilization hypothesis, our results indicate that the UK domestic credit is an exogenous variable with respect to UK foreign reserves and interest rates. This result supports the implication of the monetary approach to the balance of payments that there was no sterilization in the UK during the fixed exchange rate period.