Impact case study database

In an early article (published 2007), Schröder analysed alternative ways to estimate expected stock market returns. This information is essential for fund managers making strategic, long-term asset allocation decisions. At the same time, expected market returns are a crucial parameter in many of the asset pricing models used to determine the expected returns of individual stocks and asset prices. Schröder proposed that analyst earnings forecasts could be used for this purpose. This entirely forward-focused approach would circumvent the problems of previous models, which relied on information about past returns in order to predict future returns.

Since joining Birkbeck in 2009, Schröder has built on this research in collaboration with a co-author who is also an asset management professional. A series of three articles published in 2014, 2016, and 2018 have seen Schröder develop his original model by focusing on individual stocks rather than the market as a whole; by offering a method for estimating the equity risk, as well as the expected returns, of individual shares; and by exploring the effect of market inefficiencies on estimates of expected returns.

Using expected returns to improve equity portfolios

After the publication of his 2007 article, Schröder was approached by Florian Esterer, then a senior portfolio manager at Swisscanto Asset Management. As a practitioner, Esterer recognised the value of Schröder’s previous work. He suggested that the same approach could be used to predict individual stock returns, and the pair undertook a joint study [1] which tested the ability of expected return estimates developed on Schröder’s model to predict individual stock returns. These results were successfully applied to create portfolios which outperformed the market, even after risk adjustments and transaction costs were taken into account.

Estimating the time horizon and interest sensitivity of equities

Based on this work, Schröder and Esterer went on to estimate not only the expected returns, but also the equity risk of individual shares. A developing research literature suggests that the timing of a firm’s cash flows (such as dividends) is crucial to understanding the equity risk presented by their shares. Schröder’s and Esterer’s follow-up study [2] deployed Schröder’s method (using the forecasts created by equity analysts) to estimate the expected timing of cashflows in particular firms. This was the first study to create an entirely forward-looking estimate of equity duration, in analogy to the well-established concept of bond duration. It also shares the same interpretation of measure of a share price’s sensitivity to changes in the discount rate.

The concept of duration put forward in this study is useful for investment managers of pension funds who are seeking to assess their portfolio’s sensitivity to changes in discount rates. It can help trustees ensure a better match between their investments across asset classes and pension liabilities without sacrificing too much in the way of potential returns.

Estimating the timing and pricing of dividends

In a further study [4], Schröder refines the approach developed in previous papers to show that market equity risk premia are (i) depending on the investment time horizon and (ii) dynamically change in response to economic business cycle. This finding gives asset managers the possibility to shift their asset portfolio from long-term to short-term investments and vice versa, optimizing their exposure to a large equity risk premia.

Impact of market efficiency on expected returns estimates

Forward-looking estimates of expected stock returns assume that equity markets are efficient; i.e., that prices reflect all available information at all times. This might not, however, always be the case. In another extension to his research [3], Schröder examined the effect of market inefficiencies on expected return estimates. The study found that expected returns estimates were indeed more accurate in efficient equity markets relative to less efficient equity markets.

Estimating the timing and pricing of dividends

In a further study [4], Schröder refines the approach developed in previous papers to show that market equity risk premia are (i) depending on the investment time horizon and (ii) dynamically change in response to economic business cycle. This finding gives asset managers the possibility to shift their asset portfolio from long-term to short-term investments and vice versa, optimizing their exposure to large equity risk premia.