Fed Model

Posted in Finance, Accounting and Economics Terms, Total Reads: 268
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Definition: Fed Model

It is a type of model used by the Federal Reserve; this model is used to hypothesize a relationship between the equities market return and long term treasury notes. Not only Federal Reserve, but many of the companies in United States America use this model for evaluating equities.


In actuality the Federal Reserve doesn’t actually endorse this tool, in reality this tool was endorsed by prudential securities strategist Ed Yardeni. In the long run, the Fed model states that the bond market and also the equities market are in equilibrium and that both are fairly valued. This model has already told compares the earning yield (E/P) of stock market and also the yield on long term government bonds which in most cases are stable. SO on the long run the forward looking earnings yield of the stock market should equal the yield of a 10 year treasury note.


E\P = Y10


The below also shows example of the graph that plots the stock market return and the yield of 10 year note.


 

The model has gained significant popularity because of the following reasons:

a. It is backed by financial theory

b. It is simple

c. It is backed by empirical evidence.

 

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