Which Component of Treasury Yields Belongs in Equity Valuation Models? An Application to the S&P 500
"Which Component of Treasury Yields Belongs in Equity Valuation Models? An Application to the S&P 500," The Journal of Portfolio Management Summer 2013, 39 (4) 80-90; DOI:10.3905/jpm.2013.39.4.080
Posted: 19 Jun 2019
Date Written: 2013
Given a relaxation of the expectations hypothesis of interest rates and an estimate of the term premium, the remaining assumption that anticipated distant-horizon nominal expected short rates and projected earnings growth are equivalent implies novel cash-flow-based valuation models for shares. For example, an application of a simple dividend-discount framework to the S&P 500, under 600 alternative specifications (to avoid data mining), using a sample from January 1987 through January 2012, fits the data well. It suggests that the model errors correct; it also suggests the argument that estimated forward Treasury term premiums, not yields, belong in the discount factor.
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