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The fed model: The bad, the worse, and the ugly

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  • Estrada, Javier

Abstract

The negative relationship between stock market P/E ratios and government bond yields seems to have become conventional wisdom among practitioners. However, limited empirical evidence and a misleading suggestion that the model originated in the Fed are used to support the model's plausibility. This article argues that the Fed model is flawed from a theoretical standpoint and reports evidence from 20 countries that seriously questions its empirical merits. Despite its widespread use and acceptance, the Fed model is found to be a failure both as a normative and as a positive model of equity pricing.

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  • Estrada, Javier, 2009. "The fed model: The bad, the worse, and the ugly," The Quarterly Review of Economics and Finance, Elsevier, vol. 49(2), pages 214-238, May.
    • Handle: RePEc:eee:quaeco:v:49:y:2009:i:2:p:214-238
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    Cited by:

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    3. Acker, Daniella & Duck, Nigel W., 2013. "Inflation illusion and the US dividend yield: Some further evidence," Journal of International Money and Finance, Elsevier, vol. 33(C), pages 235-254.
    4. Bekaert, Geert & Engstrom, Eric, 2010. "Inflation and the stock market: Understanding the "Fed Model"," Journal of Monetary Economics, Elsevier, vol. 57(3), pages 278-294, April.
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    6. Dladla, Pholile & Malikane, Christopher, 2019. "Stock return predictability: Evidence from a structural model," International Review of Economics & Finance, Elsevier, vol. 59(C), pages 412-424.
    7. Zakamulin, Valeriy & Hunnes, John A., 2021. "Stock earnings and bond yields in the US 1871–2017: The story of a changing relationship," The Quarterly Review of Economics and Finance, Elsevier, vol. 79(C), pages 182-197.
    8. Misheck Mutize & Sean J. Gossel, 2019. "Sovereign Credit Rating Announcement Effects on Foreign Currency Denominated Bond and Equity Markets in Africa," Journal of African Business, Taylor & Francis Journals, vol. 20(1), pages 135-152, January.
    9. Stein, Michael & Islami, Mevlud & Lindemann, Jens, 2012. "Identifying time variability in stock and interest rate dependence," Discussion Papers 24/2012, Deutsche Bundesbank.
    10. Gozluklu, Arie & Morin, Annaïg, 2019. "Stock vs. Bond yields and demographic fluctuations," Journal of Banking & Finance, Elsevier, vol. 109(C).

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