The 'Fed Model' and the Predictability of Stock Returns

Is there a Positive Risk‐Return Tradeoff? A Forward‐Looking Approach to Measuring the Equity Premium

“…Finally, there is a long-run positive relation between the dividend (earnings) yield and the long-term government bond yield whereby deviations from this relation are transitory and serve to signal shifts in economic conditions and market returns (cf., Lander, Orphanides and Douvogiannis, 1997;Thomas and Zhang, 2008). 3 A recent article by Maio (2012) finds that this yield gapthe difference between the stock market dividend (earnings) yield and the long-term government bond yieldreliably forecasts future market returns in both short-and long-run forecasting horizons and strengthens the theoretical argument for using such an approach to empirically estimate the equity premium in the stock market.…”

Does the bond‐stock earnings yield differential model predict equity market corrections better than high P/E models?

“…The BSEYD model is closely related to the Fed Model (Estrada, 2006;Weigand & Irons, 2007;Faugère & Van Erlach, 2009;Maio, 2013;Faugère, 2013). In its most popular form, the Fed model states that in equilibrium, the one-year forward-looking earnings yield of the S&P500 should equal the current yield on a 10-year Treasury Note, that is…”

“…Lleo and Ziemba (2012) show that the BSEYD model predicted the equity market crashes in the US, Iceland and China during [2007][2008][2009]. Maio (2013) also shows that the "yield gap", which corresponds to the difference between the earnings yield (or dividend yield) on a stock market index and the long-term yield on Treasury bonds, predicts returns better than other models based on dividend yield.…”

Stock vs. Bond yields and demographic fluctuations

“…We then show empirically that the link between financial yields and a demographic variable is robust in the U.S. sample over the last century. Next, we test the relevance of demographic fluctuations within a valuation model and show how demographic information about distant future can be successfully used to forecast excess stock market returns (Lander et al, 1997;Bekaert and Engstrom, 2010;Maio, 2013). Finally, we extend the analysis to a cross-country panel, and document cross-sectional variation of the demographic effect.…”

“…This paper shows that stock and bond yields share a common demographic component that explains the slow-evolving time-series covariation. Yields to aggregate U.S. stock and government bond markets follow surprisingly similar paths in the post-war period (e.g., Bekaert and Engstrom, 2010;Maio, 2013). This evidence incites debate on the validity of rational valuation models that rely on relative pricing of stock and bond markets (Asness, 2003;Estrada, 2009).…”