Atactical implication of predictability: fighting the FED model
This paper confirms that high earnings yield portend high equity returns. Absolute valuation levels of equity have predictive power over future long run equity returns. The predictability is far less powerful in the short term. On a tactical investment horizon, investors tend to rely on the relative valuation of equity versus bonds to gauge whether equity markets are attractive. The FED model, which compares earnings yield and bond yield, is the preferred yardstick in the finance profession. First, this paper examines the FED model and shows that is not only theoretically flawed, but also not able to predict equity returns over long sample periods. Second, we improve the model by adding corrections for perceived risk enabling a better fit of the data. Third, the main innovation is testing a tactical asset allocation model constructed on the basis of the improved model. A model portfolio taking advantage of the short-term deviation in relative value, corrected for risk, leads to superior performance.
|Date of creation:||2004|
|Date of revision:|
|Contact details of provider:|| Postal: |
Phone: +31 50 363 7185
Fax: +31 50 363 3720
Web page: http://som.eldoc.ub.rug.nl/
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- John Y. Campbell & Robert J. Shiller, 2001.
"Valuation Ratios and the Long-run Stock Market Outlook: An Update,"
Cowles Foundation Discussion Papers
1295, Cowles Foundation for Research in Economics, Yale University.
- John Y. Campbell & Robert J. Shiller, 2001. "Valuation Ratios and the Long-Run Stock Market Outlook: An Update," NBER Working Papers 8221, National Bureau of Economic Research, Inc.
When requesting a correction, please mention this item's handle: RePEc:dgr:rugsom:04e07. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Joke Bulthuis)
If references are entirely missing, you can add them using this form.