On February 19th, 2020, the S&P 500 hit an all-time high of 3,386.15. Thirty-three days later, on March 23, the S&P 500 closed at 2,232.40, a 34% collapse. Between February and April, 5.3 trillion dollars of the S&P 500’s market cap was wiped out from Covid-19 Pandemic. Fast forward to the end of May, where … Read more
Estimating a single variance that is believed to be constant is straightforward: The familiar sample variance is unbiased and its precision can be enhanced by using higher-frequency data. The analyst’s task becomes more complicated if the variance is not believed to be constant or the analyst needs to forecast a variance–covariance (VCV) matrix. The VCV … Read more
Currency exchange rate forecasting is particularly difficult, causing investment managers to either fully hedge currency exposure, or accept the volatility. Currencies are units of account in which asset prices are quoted. Movements in exchange rates change the value of all assets denominated in one currency relatively to all other currencies. Perhaps even more importantly, anything … Read more
Real estate is inherently quite different from equities, bonds, and cash. It is a physical asset rather than a financial asset. It is heterogeneous, indivisible, and immobile. It is a factor of production, like capital equipment and labor, and as such, it directly produces a return in the form of services. Its services can be … Read more
he Singer-Terhaar model is based on two versions of the international Capital Asset Pricing Model (CAPM): one in which global asset markets are fully integrated, and another in which markets are fully segmented. The model then looks at the expectations of actual segmentation/integration and takes a weighted average of the two assumptions to calculate returns. The Singer-Terhaar approach begins … Read more
The Grinold-Kroner model states that the expected return of a stock is its dividend yield, plus the inflation rate, plus the real earnings growth rate, minus the change in stock outstanding, plus changes in the P/E ratio: E(Re)≈ D/P + (%ΔE − %ΔS) + %ΔP/E where: E(Re) = expected equity return D/P = dividend yield %ΔE = … Read more
When looking at a very long time horizon—over 100 years—mean real returns of equity markets in various countries do not show statistically meaningful differences. These sample averages tend to be imprecise, unless the volatility of the data is small. As we saw, shrinkage estimators are typically more reliable as predictors of equity returns. Discounted Cash … Read more
Investing in emerging market debt involves all the same risks as investing in developed country debt, such as interest rate movements, currency movements, and potential defaults. In addition, it poses risks that are, although not entirely absent, less significant in developed markets. These risks fall roughly into two categories: (1) economic and (2) political and … Read more
There are three main ways to approach forecasting fixed-income returns. The first is discounted cash flow. This method is really the only one that is precise enough to use in support of trades involving individual fixed-income securities. The second approach is the risk premium approach, which is often applied to fixed income, in part because … Read more
Although investment opportunities are not constant, virtually all forecasting techniques rely on notions of central tendency, toward which opportunities tend to revert over time. This fact means that although asset prices, risk premiums, volatilities, valuation ratios, and other metrics may exhibit momentum, persistence, and clustering in the short run, over sufficiently long horizons, they tend … Read more
Macroeconomic Linkages Macroeconomic linkages between countries are expressed through their respective current and capital accounts. The current account reflects net exports of goods and services, net investment income flows, and unilateral transfers. The capital account, which for the purposes of this discussion also includes what is known as the financial account, reflects net investment flows … Read more