Average Debt and Equity Returns: Puzzling?
By Ellen R Mcgrattan, Edward C. Prescott. 2003
206 citations recorded by the source corpus.
Mehra and Prescott (1985) found the difference between average equity and debt returns puzzling because it was too large to be a premium for bearing nondiversifiable aggregate risk. Here, we re-examine this puzzle, taking into account some factors ignored by Mehra and Prescott-taxes, regulatory constraints, and diversification costs-and focusing on long-term rather than short-term savings instruments. Accounting for these factors, we find the difference between average equity and debt returns during peacetime in the last century is less than 1 percent, with the average real equity return somewhat under 5 percent, and the average real debt return almost 4 percent. As theory predicts, the real return on debt has been close to the 4 percent average after-tax real return on capital. Similarly, as theory predicts, the real return on equity is equal to the after-tax real return on capital plus a modest premium for bearing nondiversifiable aggregate risk.
Subfields: Accounting, Finance, Strategy and Management
View Paper: https://www.semanticscholar.org/paper/9cd4c244b2c4721f0977bf957333032135139a13
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Citations in the corpus
- Borrowing Costs and the Demand for Equity over the Life Cycle (2006, unknown): “According to McGrattan and Prescott (2003), mutual fund costs range from 1.3 to 2.5% of assets per year in the period from 1980 to 2001.”
- Taxes, regulations, and the value of U.S. and U.K. corporations (2005, background): “In McGrattan and Prescott(2003b), we provide all of the details on our estimated tax rate on distributions,τdist.”
- Accounting for the Rise in Consumer Bankruptcies (2010, unknown): “Our rationale is that the return to saving in the model is a proxy for the return on capital in the economy, which McGrattan and Prescott (2003) argue has remained roughly constant over 1980-2000.”