Friday, August 18, 2017

Historical asset prices

Ananth points to the FT Alphaville article that features the new work of Oscar Jorda, Alan Taylor and Co that examines the relative rates of return for equity, housing, bonds, and bills for 16 countries over the 1870-2015 period. Their finding,
Over the long run of nearly 150 years, we find that advanced economy risky assets have performed strongly. The average total real rate of return is approximately 7% per year for equities and 8% for housing. The average total real rate of return for safe assets has been much lower, 2.5% for bonds and 1% for bills. These average rates of return are strikingly consistent over different subsamples, and they hold true whether or not one calculates these averages using GDP-weighted portfolios. Housing returns exceed or match equity returns, but with considerably lower volatility—a challenge to the conventional wisdom of investing in equities for the long-run.
A summary of their finding below shows that while returns on housing and equity have been relatively similar, the former has been much less volatile than the latter.
The relative performances of all assets with respect to bills for the period from 1870 and from 1950 are below.
FT though points to a wrinkle to this assessment, highlighting that contrary to conventional wisdom capital appreciation is a smaller share of wealth effect from housing and a significant share of the returns to housing has come in the form of rental yields, something unavailable to the typical homeowner. This coupled with the cost of mortgage taken to finance the purchase means that the real return to the homeowner from a housing asset would be far lower. 

And in a nod to Thomas Pikketty and Co, the authors find that r, the real rate of return to capital, has consistently exceeded g, the real GDP growth, in the aggregate sample, except during the wars,
A robust finding in this paper is that r ≫ g: globally, and across most countries, the weighted rate of return on capital was twice as high as the growth rate in the past 150 years... In fact the only exceptions to that rule happen in very special periods—the years in or right around wartime. In peacetime, r has always been much greater than g.
They also find that risky rates, a measure of profitability of private investment, have remained more or less constant over the past four decades, whereas risk-free rates have declined over the same period,
Both risky and safe rates of return were relatively high in the pre-WW2 era, with an obvious dip for WW1. The risk premium between risky and safe rates grew large with the Great Depression and through the Bretton Woods era. Safe real rates were especially low in WW2 up to the late 1970s. After spiking in the 1980s, the safe return has gradually declined, yet risky returns have remained relatively close to their historical average level, and the risk premium is approaching post-1980s highs... We find that the real safe rate has been very volatile over the long-run, more so than one might expect, at times even more volatile than real risky returns. 
An equally important finding is the remarkable rise in correlation of cross-country risky asset returns, in particular equity returns, and attendant risk-premiums
Historically safe rates in different countries have been more correlated than risky returns. This has reversed over the past decades, however, as cross-country risky returns have become substantially more correlated. This seems to be mainly driven by a remarkable rise in the cross-country correlations in risk premiums. This increase in global risk comovement may pose new challenges to the risk-bearing capacity of the global financial system, a trend consistent with other macro indicators of risk-sharing.
This is one more datapoint in the growing pile of evidence about the global interconnectedness and systemic risks posed by excessive financial market integration.

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