The fundamental-derived equity premium

Abstract

We investigate Fama and French’s (2002) fundamental-derived dividend growth model in 13 markets for the 1970-2011 period. We find that in most of the markets the dividend growth model produces both lower and more precise estimates of the expected equity premium than the realized average. We conclude that our results are generally consistent with expected stock returns being lower than the observed averages in the sample period. In addition, we find that the post-2000 capital gains seem to have been more in line with unconditional expectations. We see this as a reversion of the unexpected high equity returns found by Fama and French (2002) in the 90’s. Even, so we do not claim that the dividend-model alone does not fully resolve the equity premium puzzle. We think that adjustments in theoretical equilibrium models regarding risk preferences and habit persistence may be necessary to account for the outperformance of stocks over treasury bills.