Analysis of Earnings, Stock Prices and Bond Yields: The Fed Model Approach

Prediction of the stock market valuation is a common interest to all market participants. Theoretically sound market valuation can be achieved by discounting future earnings of equities to present. Competing valuation models seek to find variables that affect the equity market valuation in a way that the market valuation can be explained and also variables that could be used to predict market valuation. In this paper we test the contemporaneous relationship between stock prices, forward looking earnings and long-term government bond yields. We test this so-called Fed model in a long- and short-term time series analysis. In order to test the dynamics of the relationship, we use the cointegration framework. The data used in this study spans over four decades of various market conditions between 1964-2007, using data from United States. The empirical results of our analysis do not give support for the Fed model. We are able to show that the long-term government bonds do not play statistically significant role in this relationship. The effect of forward earnings yield on the stock market prices is significant and thus we suggest the use of standard valuation ratios when trying to predict the future paths of equity prices. Also, changes in the long-term government bond yields do not have significant short-term impact on stock prices.

The Fed Model: International Analysis

The Fed model is a widely used market valuation model. It is often used only on market analysis of the S&P 500 index as a shorthand measure for the attractiveness of equity, and as a timing device for allocating funds between equity and bonds. The Fed model assumes a fixed relationship between bond yield and earnings yield. This relationship is often assumed to be true in market valuation. In this paper we test the Fed model from historical perspective on the European markets. The markets of the United States are also includedfor comparison. The purpose of the tests is to determine if the Fed model and the underlying assumptions come true on different markets. The various tests are made on time-series data ranging from the year 1973 to the end of the year 2008. The statistical methods used are regressions analysis, cointegration analysis and Granger causality. The empirical results do not give strong support for the Fed model. The underlying relationships assumed by the Fed model are statistically not valid in most of the markets examined and therefore the model is not valid in valuation purposes generally. The results vary between the different markets which gives reason to suspect the general use of the Fed model in different market conditions and in different markets.

Grain yield, net blotch and scald of barley in Finnish official variety trials

Selostus: Ohrasato ja verkko- ja rengaslaikku virallisissa lajikekokeissa

The effects of ridging, row-spacing and seeding rate on carrot yield

Selostus: Maan muotoilun, kylvötavan ja siementiheyden vaikutus porkkanan satoon

Concentrate feeding and milk yield based on field data of milk recorded herds

Selostus: Väkirehuruokinnan vaikutus maidontuotantoon karjantarkkailutiloilta kerätyssä kenttäaineistossa

The effects of prolonged exposure to elevated temperatures and elevated CO2 levels on the growth, yield and dry matter partitioning of field-sown meadow fescue

Selostus: Kohotetun lämpötilan ja kohotetun CO2-pitoisuuden vaikutukset peltoon kylvetyn nurminadan kasvuun, satoon ja kuiva-aineen jakautumiseen

Impact of global warming on potato late blight : risk, yield loss and control

Selostus: Ilmaston lämpenemisen vaikutus perunaruttoon

Effects of fertilisation and irrigation practices on yield, maturity and storability of onions

Selostus: Lannoituksen ja kastelun vaikutus sipulin satoon, sadon valmistumiseen ja varastokestävyyteen

Growth, yield and secondary metabolite production of Drosera species cultivated in peat beds in Finland

Tiivistelmä

The effect of regular collection of Drosera rotundifolia in natural peatlands in Finland: plant density, yield and regeneration

Tiivistelmä

Responses of yield and N use of spring sown crops to N fertilization, with special reference to the use of plant growth regulators

Selostus: Typpilannoituksen ja kasvunsääteiden vaikutukset kevätviljojen ja rypsin satoon sekä typen käyttöön

Effect of milk coagulation properties of herd bulk milks on yield and composition of Emmental cheese

Selostus: Tankkimaidon juoksettumisominaisuuksien vaikutus Emmental-juuston määrään ja koostumukseen

Timing of primary growth harvest affects the yield and nutritive value of timothy-red clover mixtures

Selostus: Ensimmäisen sadon korjuuaika vaikuttaa timotein ja puna-apilan seosnurmen satoon ja rehuarvoon