The RDM Forecasting matrix Javier Estrada Rather trivial to - - PDF document

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The RDM Forecasting matrix Javier Estrada Rather trivial to - - PDF document

May 29, 2023 461 likes •600 views

Application 2: Forecasting & Downside Risk Javier Estrada ADFIN Winter/2014 1. Forecasting Back to the RDM D/P, P/E, and CAPE The Fed model 2. Downside Risk Calculation of semideviations Further thoughts on VaR The RDM

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Application 2:

Forecasting & Downside Risk

Javier Estrada ADFIN – Winter/2014

  • 1. Forecasting
  • Back to the RDM
  • D/P, P/E, and CAPE
  • The Fed model
  • 2. Downside Risk
  • Calculation of semideviations
  • Further thoughts on VaR

Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014

The RDM

  • Forecasting matrix
  • Rather trivial to calculate
  • Just remember to annualize the changes in P/E
  • Take DY0 and P/E0 out of the table

GoXls

  • An interesting thought that follow from the RDM
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Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014

Multiples

  • Simple idea
  • The higher the price paid per dollar of fundamental

value (E, B, D, …), the lower the subsequent return

  • The more you pay, the less you get
  • Focus on three widely‐used multiples
  • P/E, (the inverse of) P/D, and CAPE
  • Theory v. evidence
  • The evidence is uncontroversial
  • High relative prices tend to be followed by low returns
  • Why this happens is controversial
  • Goes back to whether value riskier than growth

Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014

D/P

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Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014

D/P

1.2% 8.0% 9.9% 11.1% 13.9% 16.8%

Avg (1900‐2009): 4.2% Jan/1/2014: 1.9%

(*) 10‐year subsequent returns, annualized

Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014

P/E

14.7% 10.1% 7.2% 8.1% 4.2%

(*) 10‐year subsequent returns, annualized

Avg (1900‐2009): 15.8 Jan/1/2013: 18.9

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Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014

Cyclically‐Adjusted P/E (CAPE)

(*) 10‐year subsequent returns, annualized

6.0% 2.3% 1.6% ‐0.7% ‐1.5%

Avg (1871‐2013): 16.5 Jan/1/2013: 25.0

  • What is CAPE?

Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014

CAPE

  • Three important points on CAPE
  • CAPE data for the US market is available from Bob

Shiller’s Web page

Go

  • CAPE is becoming increasingly popular/discussed

as a market valuation tool

  • ETFs with CAPE‐based active strategies are now

available in the market

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Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014

CAPE

Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014

CAPE

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Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014

CAPE

(*) Faber & Dalmia (JoI, 2013), “Global Value.”

Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014

Fed Model

  • The model
  • Not really proposed or used by the Fed
  • Just a relationship mentioned in a Fed report
  • Long history as an informal ‘P/E check’
  • Negative relationship between P/E and interest rates
  • Negative relationship between P/E and inflation
  • Underlying idea
  • Stocks and bonds are competitive assets in portfolios

 Investors base their asset allocation on the relative expected returns of stocks and bonds

E/P = Y10

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Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014

Fed Model

Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014

Fed Model – USA

E/P = Y10 P* = E/Y10

P*: 2992.2 P: 1848.4

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Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014

Fed Model – USA

P/P*: 0.62 ⇒ +61.9%

Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014

‘Fed Model’ – USA

D/P: 1.9% Y10: 3.0%

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Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014

Fed Model – World ($)

P*: 3267.6 P: 1629.1

Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014

Fed Model – World ($)

P/P*: 0.50 ⇒ +100.6%

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Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014

‘Fed Model’ – World ($)

D/P: 2.4% Y10: 3.0%

Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014

Downside Risk – SSD (& DB)

  • How risk is assessed will critically determine

financial decisions to be made

  • There are easy (one‐cell) ways to calculate …
  • semideviations
  • downside betas

GoXls

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Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014

Downside Risk – VaR (E. Derman)

Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014

Downside Risk – VaR (M. Stanley)

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Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014

Downside Risk – VaR (M. Stanley)

Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014

Downside Risk – VaR