journal article
Open Access Collection
A New Stock Market Valuation Measure with Applications to Equity-Linked Annuities
2019 Quantitative Finance
doi: 10.48550/arXiv.1905.04603pmid: N/A
Abstract: We propose a new stock market valuation measure. We use the USA stock market data from 1871. We split total returns into three components: earnings growth, dividend yield, and valuation change. The first two components are fundamental, the third is speculative. We treat earnings growth as exogenous. Combining the other two components gives us a new valuation measure, which fits autoregression of order 1 with Gaussian innovations, centered at 4.6\%. Therefore, long-term total returns equal long-term earnings growth plus 4.6\%. We confirm the classic 4\% withdrawal rule for investing in stocks: A retiree should invest in stocks and withdraw 4\% of initial wealth after adjusting for inflation. This is useful for equity-linked annuities, which invest retiree's savings used for annuity purchase into the stock market.