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Some historical perspectives on the Bond-Stock Earnings Yield Model for crash prediction around the world

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  • Lleo, Sébastien
  • Ziemba, William T.

Abstract

We provide a historical background on Ziemba’s experiences and research on the bond-stock earnings yield differential model (BSEYD), from the time he first used it in Japan in 1988 through to the present in 2014. Over this period, the model has called many crashes, but not all. Those called have had high interest rates in long term bonds relative to the trailing earnings to price ratio. In general, there will almost always be a crash if the model is in the danger zone. The model predicted the crashes in China, Iceland and the US in the 2006–09 period. Iceland had a drop of fully 95%. For the US, the call was on June 14, 2007, and the stock market fell 56.8%. A longer-term study for the US, Canada, Japan, Germany, and the UK shows that, over long periods, being in the stock market when the bond-stock signal is not in the danger zone, and in cash when it is in the danger zone, provides a final wealth which is about double that of a buy and hold strategy for each of these five countries. The best use of the model is for predicting crashes. Finally, we compare Shiller’s high PE ratio crash model to the BSEYD model for the US market from 1962–2012. While both models add value, the BSEYD model predicts crashes better.

Suggested Citation

  • Lleo, Sébastien & Ziemba, William T., 2015. "Some historical perspectives on the Bond-Stock Earnings Yield Model for crash prediction around the world," International Journal of Forecasting, Elsevier, vol. 31(2), pages 399-425.
  • Handle: RePEc:eee:intfor:v:31:y:2015:i:2:p:399-425
    DOI: 10.1016/j.ijforecast.2015.02.001
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    References listed on IDEAS

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    1. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "Varieties of Crises and Their Dates," Introductory Chapters, in: This Time Is Different: Eight Centuries of Financial Folly, Princeton University Press.
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    Cited by:

    1. Sébastien Lleo & William T. Ziemba, 2013. "Stock Market Crashes In 2007–2009: Were We Able To Predict Them?," World Scientific Book Chapters, in: Oliviero Roggi & Edward I Altman (ed.), Managing and Measuring Risk Emerging Global Standards and Regulations After the Financial Crisis, chapter 13, pages 457-499, World Scientific Publishing Co. Pte. Ltd..
    2. Lleo, Sebastien & Ziemba, William T., 2017. "A tale of two indexes: predicting equity market downturns in China," LSE Research Online Documents on Economics 85131, London School of Economics and Political Science, LSE Library.
    3. Lleo, Sebastien & Ziemba, William T., 2014. "Does the bond-stock earning yield differential model predict equity market corrections better than high P/E models?," LSE Research Online Documents on Economics 59290, London School of Economics and Political Science, LSE Library.
    4. Shiryaev, Albert N. & Zhitlukhin, Mikhail N. & Ziemba, Bill & Ziemba, William T., 2014. "Land and stock bubbles, crashes and exit strategies in Japan circa 1990 and in 2013," LSE Research Online Documents on Economics 59288, London School of Economics and Political Science, LSE Library.

    More about this item

    Keywords

    Stock market crashes; BSEYD and Fed models; Long term investing;

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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