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Re: [Behavioral-Finance] Quantifying and Forecasting an Equity Risk Factor

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  • Kwok Yeung
    I have found the article enclosed interesting. But I have hard time to find how the RA is being calculated (other than being speculated). To forecast the RA
    Message 1 of 5 , May 22, 2007
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      I have found the article enclosed interesting. But I
      have hard time to find how the RA is being calculated
      (other than being speculated).

      To forecast the RA based on the trend of data in past
      decades could ignore changes of many important
      factors.

      The Fed model is simple, assuming that the RA and
      earnings growth etc. offset each other. But it clearly
      shows the opportunity cost of bonds and stocks in
      terms of PE in very short term when the RA and other
      factors may not change much.

      Last but not least, for the equation of P = E / (Y +
      RA), I think there should be more in the denominator,
      in addition to Y and RA.

      K.C.


      --- Bob Bronson <bob@...> wrote:

      > The currently popular so-called Fed Model is
      > incomplete, and
      >
      > thus grossly inaccurate empirically, but it can be
      > simply fixed
      >
      > by adding a Risk Aversion factor as demonstrated
      > here:
      >
      >
      http://financialsense.com/editorials/bronson/2007/0412.html
      >
      >
      >
      > I more than welcome any questions, comments and/or
      > critique.
      >
      >
      >
      > Sincerely,
      >
      >
      >
      > Bob Bronson
      >
      > Bronson Capital Markets Research
      >
      >
      http://financialsense.com/editorials/bronson/main.html
      >
      >
      >
      >
      >
      >
    • Bob Bronson
      Thanx for your thoughtful feedback, Kwok. My responses and question are interspersed below. ... From: Behavioral-Finance@yahoogroups.com
      Message 2 of 5 , May 22, 2007
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        Thanx for your thoughtful feedback, Kwok.

        My responses and question are interspersed below.


        -----Original Message-----
        From: Behavioral-Finance@yahoogroups.com
        [mailto:Behavioral-Finance@yahoogroups.com] On Behalf Of Kwok Yeung
        Sent: Tuesday, May 22, 2007 3:07 PM
        To: Behavioral-Finance@yahoogroups.com
        Subject: Re: [Behavioral-Finance] Quantifying and Forecasting an Equity Risk
        Factor

        I have found the article enclosed interesting. But I
        have hard time to find how the RA is being calculated
        (other than being speculated).

        <The definition results from the simple one-factor fix
        of the difference between the corporate earnings yield
        and the 10-year T-bond yield -- which otherwise might
        be considered to be only the forecasting error -- is
        wholly due to a missing equity risk factor. In this
        simple presentation it called Risk Aversion factor since
        there are several commonly, and often confusingly, used
        equity risk metrics, as explained.>

        To forecast the RA based on the trend of data in past
        decades could ignore changes of many important factors.

        <True, but this also applies to forecasting time-varying
        corporate earnings and the stock market P/E ratio, which
        we cover in our P/E Predictor Study II. This report was
        generated to, among other things, to simply demonstrate
        that the so-called Fed Model is theoretically incomplete
        and empirically is grossly inaccurate.>

        The Fed model is simple, assuming that the RA and earnings
        growth etc. offset each other.

        <What do you mean "offset each other? You mention "growth"
        but The Fed Model does not involve "growth." If you mean
        E/P and Y they should be equal (at equilibrium), theory
        and history clearly show that (equilibrium) assumption is
        simply not true, even if currently popular.>

        But it clearly shows the opportunity cost of bonds and
        stocks in terms of PE in very short term when the RA and
        other factors may not change much.

        <But other factors are demonstrably even more important
        and their aggregate, which we call Risk Aversion in this
        simple presentation, change very significantly over time.>

        Last but not least, for the equation of P = E / (Y + RA),
        I think there should be more in the denominator, in addition
        to Y and RA.

        <Yes, and as mentioned, we cover many in our P/E Predictor
        Predictor Study II. Which other factors do you have in mind?>

        K.C.


        --- Bob Bronson <bob@...> wrote:

        > The currently popular so-called Fed Model is incomplete,
        > and thus grossly inaccurate empirically, but it can be
        > simply fixed by adding a Risk Aversion factor as demonstrated
        > here:
        > http://financialsense.com/editorials/bronson/2007/0412.html
        >
        > I more than welcome any questions, comments and/or
        > critique.
        >
        > Sincerely,
        > Bob Bronson
        > Bronson Capital Markets Research
        http://financialsense.com/editorials/bronson/main.html
      • Alex Spiroglou
        Hussaman s view http://www.hussmanfunds.com/wmc/wmc070521.htm ... From: Bob Bronson To: Behavioral-Finance@yahoogroups.com Sent: Wednesday, May 23, 2007 1:14
        Message 3 of 5 , May 23, 2007
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          Hussaman's view
           
           
          ----- Original Message -----
          Sent: Wednesday, May 23, 2007 1:14 AM
          Subject: [Behavioral-Finance] Response to feedback RE: Quantifying and Forecasting an Equity Risk Factor

          Thanx for your thoughtful feedback, Kwok.

          My responses and question are interspersed below.

          -----Original Message-----
          From: Behavioral-Finance@ yahoogroups. com
          [mailto:Behavioral-Finance@ yahoogroups. com] On Behalf Of Kwok Yeung
          Sent: Tuesday, May 22, 2007 3:07 PM
          To: Behavioral-Finance@ yahoogroups. com
          Subject: Re: [Behavioral- Finance] Quantifying and Forecasting an Equity Risk
          Factor

          I have found the article enclosed interesting. But I
          have hard time to find how the RA is being calculated
          (other than being speculated).

          <The definition results from the simple one-factor fix
          of the difference between the corporate earnings yield
          and the 10-year T-bond yield -- which otherwise might
          be considered to be only the forecasting error -- is
          wholly due to a missing equity risk factor. In this
          simple presentation it called Risk Aversion factor since
          there are several commonly, and often confusingly, used
          equity risk metrics, as explained.>

          To forecast the RA based on the trend of data in past
          decades could ignore changes of many important factors.

          <True, but this also applies to forecasting time-varying
          corporate earnings and the stock market P/E ratio, which
          we cover in our P/E Predictor Study II. This report was
          generated to, among other things, to simply demonstrate
          that the so-called Fed Model is theoretically incomplete
          and empirically is grossly inaccurate.>

          The Fed model is simple, assuming that the RA and earnings
          growth etc. offset each other.

          <What do you mean "offset each other? You mention "growth"
          but The Fed Model does not involve "growth." If you mean
          E/P and Y they should be equal (at equilibrium) , theory
          and history clearly show that (equilibrium) assumption is
          simply not true, even if currently popular.>

          But it clearly shows the opportunity cost of bonds and
          stocks in terms of PE in very short term when the RA and
          other factors may not change much.

          <But other factors are demonstrably even more important
          and their aggregate, which we call Risk Aversion in this
          simple presentation, change very significantly over time.>

          Last but not least, for the equation of P = E / (Y + RA),
          I think there should be more in the denominator, in addition
          to Y and RA.

          <Yes, and as mentioned, we cover many in our P/E Predictor
          Predictor Study II. Which other factors do you have in mind?>

          K.C.

          --- Bob Bronson <bob@bronsons. com> wrote:

          > The currently popular so-called Fed Model is incomplete,
          > and thus grossly inaccurate empirically, but it can be
          > simply fixed by adding a Risk Aversion factor as demonstrated
          > here:
          > http://financialsen se.com/editorial s/bronson/ 2007/0412. html
          >
          > I more than welcome any questions, comments and/or
          > critique.
          >
          > Sincerely,
          > Bob Bronson
          > Bronson Capital Markets Research
          http://financialsen se.com/editorial s/bronson/ main.html

        • Bob Bronson
          Yes, Hussman has just reported that he is very critical of the so-called Fed Model, but he does not offer an equity risk factor solution, or any other fix.
          Message 4 of 5 , May 23, 2007
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            Yes, Hussman has just reported that he is very critical of the

            so-called Fed Model, but he does not offer an “equity risk factor”

            solution, or any other fix.

             

            Hopefully, this forum is interested in discussing ways to fix the

            institutionally-popular model since the behavioral bias of risk

            aversion is a major part of what’s missing.

             


            From: Behavioral-Finance@yahoogroups.com [mailto: Behavioral-Finance@yahoogroups.com ] On Behalf Of Alex Spiroglou
            Sent: Wednesday, May 23, 2007 3:02 AM
            To: Behavioral-Finance@yahoogroups.com
            Subject: Re: [Behavioral-Finance] Response to feedback RE: Quantifying and Forecasting an Equity Risk Factor

             

            Hussaman's view

             

             

            ----- Original Message -----

            Sent: Wednesday, May 23, 2007 1:14 AM

            Subject: [Behavioral-Finance] Response to feedback RE: Quantifying and Forecasting an Equity Risk Factor

             

            Thanx for your thoughtful feedback, Kwok.

            My responses and question are interspersed below.

            -----Original Message-----
            From: Behavioral-Finance@ yahoogroups. com
            [mailto:Behavioral-Finance@ yahoogroups. com] On Behalf Of Kwok Yeung
            Sent: Tuesday, May 22, 2007 3:07 PM
            To: Behavioral-Finance@ yahoogroups. com
            Subject: Re: [Behavioral- Finance] Quantifying and Forecasting an Equity Risk
            Factor

            I have found the article enclosed interesting. But I
            have hard time to find how the RA is being calculated
            (other than being speculated).

            <The definition results from the simple one-factor fix
            of the difference between the corporate earnings yield
            and the 10-year T-bond yield -- which otherwise might
            be considered to be only the forecasting error -- is
            wholly due to a missing equity risk factor. In this
            simple presentation it called Risk Aversion factor since
            there are several commonly, and often confusingly, used
            equity risk metrics, as explained.>

            To forecast the RA based on the trend of data in past
            decades could ignore changes of many important factors.

            <True, but this also applies to forecasting time-varying
            corporate earnings and the stock market P/E ratio, which
            we cover in our P/E Predictor Study II. This report was
            generated to, among other things, to simply demonstrate
            that the so-called Fed Model is theoretically incomplete
            and empirically is grossly inaccurate.>

            The Fed model is simple, assuming that the RA and earnings
            growth etc. offset each other.

            <What do you mean "offset each other? You mention "growth"
            but The Fed Model does not involve "growth." If you mean
            E/P and Y they should be equal (at equilibrium) , theory
            and history clearly show that (equilibrium) assumption is
            simply not true, even if currently popular.>

            But it clearly shows the opportunity cost of bonds and
            stocks in terms of PE in very short term when the RA and
            other factors may not change much.

            <But other factors are demonstrably even more important
            and their aggregate, which we call Risk Aversion in this
            simple presentation, change very significantly over time.>

            Last but not least, for the equation of P = E / (Y + RA),
            I think there should be more in the denominator, in addition
            to Y and RA.

            <Yes, and as mentioned, we cover many in our P/E Predictor
            Predictor Study II. Which other factors do you have in mind?>

            K.C.

            --- Bob Bronson <bob@bronsons. com> wrote:

            > The currently popular so-called Fed Model is incomplete,
            > and thus grossly inaccurate empirically, but it can be
            > simply fixed by adding a Risk Aversion factor as demonstrated
            > here:
            > http://financialsen se.com/editorial s/bronson/ 2007/0412. html
            >
            > I more than welcome any questions, comments and/or
            > critique.
            >
            > Sincerely,
            > Bob Bronson
            > Bronson Capital Markets Research
            http://financialsen se.com/editorial s/bronson/ main.html

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