The widely used Fed model leads too many analysts, portfolio managers and financial commentators down the wrong road. It often leads investors to believe that by comparing two numbers – earnings yields and bond yields – they can easily determine whether the stock market is mispriced. Even worse, some investors believe that such a simple comparison is the shortcut to abnormal returns.
In the paper “The Fed Model: The Bad, the Worse, and the Ugly,” IESE fFnancial Management Professor Javier Estrada proclaims that the Fed model is flawed. To support his theoretical argument, he provides evidence from 20 countries that seriously questions the model’s empirical merits.
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