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Fed Model

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 ...

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]
… Volume 57, Issue 3, April 2010, Pages 278-294. Journal of Monetary Economics … but rather use empirical proxies for the structural determinants of risk premiums suggested by these models … these proxies we show that a rational channel explains why the Fed model “works”: high …

The fed model: The bad, the worse, and the uglyThe fed model: The bad, the worse, and the ugly
www.sciencedirect.com [PDF]
… Volume 57, Issue 3, April 2010, Pages 278-294. Journal of Monetary Economics … but rather use empirical proxies for the structural determinants of risk premiums suggested by these models … these proxies we show that a rational channel explains why the Fed model “works”: high …

The “Fed model” and the predictability of stock returnsThe “Fed model” and the predictability of stock returns
academic.oup.com [PDF]
… Volume 57, Issue 3, April 2010, Pages 278-294. Journal of Monetary Economics … but rather use empirical proxies for the structural determinants of risk premiums suggested by these models … these proxies we show that a rational channel explains why the Fed model “works”: high …

A tactical implication of predictability: Fighting the fed modelA tactical implication of predictability: Fighting the fed model
joi.pm-research.com [PDF]
… Volume 57, Issue 3, April 2010, Pages 278-294. Journal of Monetary Economics … but rather use empirical proxies for the structural determinants of risk premiums suggested by these models … these proxies we show that a rational channel explains why the Fed model “works”: high …

An international test of the Fed modelAn international test of the Fed model
link.springer.com [PDF]
… Volume 57, Issue 3, April 2010, Pages 278-294. Journal of Monetary Economics … but rather use empirical proxies for the structural determinants of risk premiums suggested by these models … these proxies we show that a rational channel explains why the Fed model “works”: high …

The fed and interest rates-a high-frequency identificationThe fed and interest rates-a high-frequency identification
pubs.aeaweb.org [PDF]
… Volume 57, Issue 3, April 2010, Pages 278-294. Journal of Monetary Economics … but rather use empirical proxies for the structural determinants of risk premiums suggested by these models … these proxies we show that a rational channel explains why the Fed model “works”: high …

The'Fed Model'and the Changing Correlation of Stock and Bond Returns: An Equilibrium ApproachThe'Fed Model'and the Changing Correlation of Stock and Bond Returns: An Equilibrium Approach
papers.ssrn.com [PDF]
… Volume 57, Issue 3, April 2010, Pages 278-294. Journal of Monetary Economics … but rather use empirical proxies for the structural determinants of risk premiums suggested by these models … these proxies we show that a rational channel explains why the Fed model “works”: high …

Fight the Fed model: the relationship between stock market yields, bond market yields, and future returnsFight the Fed model: the relationship between stock market yields, bond market yields, and future returns
papers.ssrn.com [PDF]
… Volume 57, Issue 3, April 2010, Pages 278-294. Journal of Monetary Economics … but rather use empirical proxies for the structural determinants of risk premiums suggested by these models … these proxies we show that a rational channel explains why the Fed model “works”: high …



Q&A About Fed Model


What is the Fed Model?

The Fed model is a tool used by security analysts to value equities.

Where did this model get its name from?

It was named after Prudential Securities strategist Ed Yardeni.

What does it mean if the S&P 500's earning yield is higher than the U.S.'s bond yield?

It means that investors are bullish on stocks because they think stocks will outperform bonds in terms of return on investment over time.

What is the Fed model?

The Fed model is a stock market indicator that uses earnings yield to predict the direction of the stock market.

How does the Fed model relate to long-term Treasury notes?

Long-term Treasury notes are thought to be related to S&P 5 earnings yield.

Who popularized this indicator after Fisher and Moore published their findings?

Arthur Laffer popularized this indicator after he wrote about it in his book "The Wall Street Journal" article "The Capital Gains Tax Cut" (1978) .

Why would you want to use an earnings yield as opposed to just using a P/E ratio?

An earnings yield takes into account both price and dividends, which can be important when considering how much money investors are making from their investments.

What does it mean if the S&P 500's earning yield dips below the U.S.'s bond yield?

It means that investors are bearish on stocks because they think stocks will underperform bonds in terms of return on investment over time.

What does the Fed model use for its calculations?

The Fed model uses earnings yields and bond yields.

What does this model suggest about returns on 1-year Treasury notes?

This model suggests that returns on 1-year Treasury notes should be similar to the S&P 5 earnings yield.

When was this indicator first used?

This indicator was first used in 1926 by Irving Fisher, who developed it with economist Henry Ludwell Moore at Yale University during World War I as part of their work developing ways to stabilize commodity prices with government intervention (see also Fisher effect).

How do you calculate an earnings yield?

Earnings yield is calculated by dividing a company's annual EPS by its current share price.