Abstract

http://ssrn.com/abstract=1331697
 
 

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A Required Yield Theory of Stock Market Valuation and Treasury Yield Determination


Christophe Faugère


Kedge Business School Bordeaux

Julian Van Erlach


Nexxus Wealth Technologies, Inc.


Financial Markets, Institutions & Instruments, Vol. 18, Issue 1, pp. 27-88, February 2009

Abstract:     
Stock market valuation and Treasury yield determination are consistent with the Fisher effect (1896) as generalized by Darby (1975) and Feldstein (1976). The U.S. stock market (S&P 500) is priced to yield ex-ante a real after-tax return directly related to real long-term GDP/capita growth (the required yield). Elements of our theory show that: (1) real after-tax Treasury and S&P 500 forward earnings yields are stationary processes around positive means; (2) the stock market is indeed priced as the present value of expected dividends with the proviso that investors are expecting fast mean reversion of the S&P 500 nominal growth opportunities to zero. Moreover, (3) the equity premium is mostly due to business cycle risk and is a direct function of below trend expected productivity, where productivity is measured by the growth in book value of S&P 500 equity per-share. Inflation and fear-based risk premia only have a secondary impact on the premium. The premium is always positive or zero with respect to long-term Treasuries. It may be negative for short-term Treasuries when short-term productivity outpaces medium and long run trends. Consequently: (4) Treasury yields are mostly determined in reference to the required yield and the business cycle risk premium; (5) the yield spread is largely explained by the differential of long-term book value per share growth vs. near term growth, with possible yield curve inversions. Finally, (6) the Fed model is partially validated since both the S&P 500 forward earnings yield and the ten-year Treasury yield are determined by a common factor: the required yield.

Number of Pages in PDF File: 62

Accepted Paper Series


Date posted: January 25, 2009  

Suggested Citation

Faugère, Christophe and Van Erlach, Julian, A Required Yield Theory of Stock Market Valuation and Treasury Yield Determination. Financial Markets, Institutions & Instruments, Vol. 18, Issue 1, pp. 27-88, February 2009. Available at SSRN: http://ssrn.com/abstract=1331697 or http://dx.doi.org/10.1111/j.1468-0416.2008.00146.x

Contact Information

Christophe Faugère (Contact Author)
Kedge Business School Bordeaux ( email )
Domaine de Luminy - BP 921
BP 921
Marseille, PACA 13288
France
Julian Van Erlach
Nexxus Wealth Technologies, Inc. ( email )
17-15 Hunt Ridge Dr.
Clifton Park, NY 12065
United States
518-373-9650 (Phone)
Feedback to SSRN


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