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Cointegration analysis of the Fed model |
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| Authors: | Matti Koivu Teemu Pennanen William T. Ziemba |
| Affiliation: | aRisk Management Division, European Central Bank, D-60311 Frankfurt am Main, Germany bDepartment of Management Science, Helsinki School of Economics, 00101 Helsinki, Finland cSauder School of Business, University of British Columbia, Vancouver, B.C. Canada V6T 1Z2 dSloan School of Management, Massachusetts Institute of Technology, Cambridge, MA 02142, USA |
| Abstract: | The Fed model postulates that the equity earnings yield follows the bond yield in the long run. Our tests based on a cointegration analysis of the United States, United Kingdom and German data indicate that the Fed model has predictive power in forecasting changes in the equity prices, earnings and bond yields. The predictions are better in the US than in other countries. Our approach consists of building a Vector Equilibrium Correction model which provides a quantitative dynamic version of the Fed model. |
| Keywords: | Cointegration analysis Vector equilibrium correction VAR Stock markets |
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