Definition
The “Fed model” is a theory of equity valuation that has found broad application in the investment community. The model compares the stock market’s earnings yield to the yield on long-term government bonds. In its strongest form the Fed model states that bond and stock market are in equilibrium, and fairly valued, when the one-year forward-looking earnings yield equals the 10-year Treasury note yield …
Fed Model
What is ‘Fed Model’
A model thought to be used by the Federal Reserve that hypothesizes a relationship between long-term Treasury notes and the market return of equities. Many security analysts use this model in valuing equities.
Explaining ‘Fed Model’
The Fed doesn’t endorse this tool. In fact, it was named the “Fed model” by Prudential Securities strategist Ed Yardeni.
This model suggests that returns on 10-year Treasury notes should be similar to the S&P 500 earnings yield. Differences in these returns identify an overpriced or underpriced securities market.
Further Reading
- Inflation and the stock market: Understanding the “Fed Model” – www.sciencedirect.com [PDF]
- The fed model: The bad, the worse, and the ugly – www.sciencedirect.com [PDF]
- The “Fed model” and the predictability of stock returns – academic.oup.com [PDF]
- A tactical implication of predictability: Fighting the fed model – joi.pm-research.com [PDF]
- An international test of the Fed model – link.springer.com [PDF]
- The fed and interest rates-a high-frequency identification – pubs.aeaweb.org [PDF]
- The'Fed Model'and the Changing Correlation of Stock and Bond Returns: An Equilibrium Approach – papers.ssrn.com [PDF]
- Fight the Fed model: the relationship between stock market yields, bond market yields, and future returns – papers.ssrn.com [PDF]
