JORDÀ O et al., “The Rate of Return on Everything, 1870–2015". Federal Reserve Bank of San Francisco, 2017
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Abstract
This paper answers fundamental questions that have preoccupied modern economic thought since the 18th century. What is the aggregate real rate of return in the economy? Is it higher than the growth rate of the economy and, if so, by how much? Is there a tendency for returns to fall in the long-run? Which particular assets have the highest long-run returns? We answer these questions on the basis of a new and comprehensive dataset for all major asset classes, including—for the first time—total returns to the largest, but oft ignored, component of household wealth, housing. The annual data on total returns for equity, housing, bonds, and bills cover 16 advanced economies from 1870 to 2015, and our new evidence reveals many new insights and puzzles. Keywords: return on capital, interest rates, yields, dividends, rents, capital gains, risk premiums, household wealth, housing markets.
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Major findings. We summarize our four main findings as follows.
1. On risky returns, r risky
Until this paper, we have had no way to know rates of return on all risky assets in the long run. Research could only focus on the available data on equity markets (Campbell, 2003; Mehra and Prescott, 1985). We uncover several new stylized facts. In terms of total returns, residential real estate and equities have shown very similar and high real total gains, on average about 7% per year. Housing outperformed equity before WW2. Since WW2, equities have outperformed housing on average, but only at the cost of much higher volatility and higher synchronicity with the business cycle. The observation that housing returns are similar to equity returns, yet considerably less volatile, is puzzling. Diversification with real estate is admittedly harder than with equities. Aggregate numbers do obscure this fact although accounting for variability in house prices at the local level still appears to leave a great deal of this housing puzzle unresolved. Before WW2, the real returns on housing and equities (and safe assets) followed remarkably similar trajectories. After WW2 this was no longer the case, and across countries equities then experienced more frequent and correlated booms and busts. The low covariance of equity and housing returns reveals significant aggregate diversification gains (i.e., for a representative agent) from holding the two asset classes. Absent the data introduced in this paper, economists had been unable to quantify these gains.
One could add yet another layer to this discussion, this time by considering international diversification. It is not just that housing returns seem to be higher on a rough, risk-adjusted basis. It is that, while equity returns have become increasingly correlated across countries over time (specially since WW2), housing returns have remained uncorrelated. Again, international diversification may be even harder to achieve than at the national level. But the thought experiment suggests that the ideal investor would like to hold an internationally diversified portfolio of real estate holdings, even more so than equities.
2. On safe returns, r safe
