Cointegration Analysis of the Fed Model

12 Pages Posted: 8 Apr 2005

See all articles by Matti Koivu

Matti Koivu

European Central Bank (ECB)

Teemu Pennanen

Aalto University

William T. Ziemba

University of British Columbia (UBC) - Sauder School of Business; Systemic Risk Centre - LSE

Date Written: March 6, 2005


The Fed Model assumes that, the equity earnings yield follows the bond yield in the long run. This effect can be used to predict changes in the equity prices when the yields are far apart. Our tests based on a cointegration analysis of the United States, United Kingdom and German data indicate that the Fed model has predictive power. The predictions are better in the US than other countries and better for predicting crashes than for subsequent price rises. This approach also yields a quantification of the conditional distributions, and suggests a dynamic version of the Fed model in the form of a linear time series model.

Keywords: Cointegration analysis, Vector equilibrium correction, VAR, Stock markets

JEL Classification: G12, G14, G18, C51, C52, C53

Suggested Citation

Koivu, Matti and Pennanen, Teemu and Ziemba, William T., Cointegration Analysis of the Fed Model (March 6, 2005). Sauder School of Business Working Paper, Available at SSRN: or

Matti Koivu

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314

Teemu Pennanen

Aalto University ( email )

P.O. Box 21210
Helsinki 00100, 00101

William T. Ziemba (Contact Author)

University of British Columbia (UBC) - Sauder School of Business ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2
604-261-1343 (Phone)
604-263-9572 (Fax)


Systemic Risk Centre - LSE ( email )

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