CAP Market Expects Flashcards
7 Steps in creating a capital market expectation
- Determine asset and time horizon of forecast
- Research history
- Specify methods of determining expectations
- Find sources of data
- Intepret current market conditions
- Provide Expectations
Monitor
Name 9 challenges in forecasting capital market expectations
Limitations on economic data
Errors and biases
Historic estimates (covariance stationary)
Expost data is bias
Analyst methods
Conditional information
Misintepreting correlations
Psycological biases
Name and explain the 6 psycological biases to capital market expectations
- Achoring - high inportance on first thing heard
- Status quo - thinking things will remain the same
- Confirmation bias
- overconfidence bias - thinking youre hectic
- Prudence bias - not acting because scared
- Avalaiblity bias - being heavily influenced by recent big events
What are the limitations to economic data
is historic
Data is revised
definitions and calculations change on published data
What sort of errors in data can be seen?
Transcript (muffings)
Survivorship bias
Smoothed data
Historic estimates - why bad in capital market expectations
Historic data does not always have the same underlying regime when looked at over multiple periods - so like gold v usd over 200 years would not be useful
Analyst methods that effect capital market expectations
Data mining - bad
Correlation does not equal caustation
free answer
You are at the bottom of the business cycle, in a trough, what does that mean for the yield curve and why
The yield curve going to start to steepen - why? Loose monetary and fiscal policy Steepening yield curve
Yc points direction of economy movement
Top of the peak of the business cycle, what does this mean for monetray and fiscal policy AND the yield curve
Restrictive monetary and fiscal policy which means a inverted yield curve
What is an exogenus shock, and what 5 things may cause it
Natural disaster financial disaster War (policitcal event) Government policy Tech advancements Discovery of natural resources
3 ways to forecast economic policy?
Econometrics
Economic indicators
checklist approach
Deflation, what does it mean for bond, stock and real estate
Bond up - IR down = higher bond price
Stock down = less value = down
Real estate down = increased deafult rates
Why is it hard to stimulate a deflationary market
IR are so close to 0 that no monetary policy will work
Taylor rule = what is it
Taylor rule = Nominal rate +.5( expected GDP - Target GDP) + .5(Expected inflation-target inflation)
If the taylor rule outcome is LOWER than the policy rate of a central bank - what should they do
Lower = loosen`
What are the 3 formal tools for forecasting risk premias
Statistical tools
DCF
Risk build ups
What are the 3 statistical tools for forecasting capital market expectations
Sample statistics
Shrinkage estimations
Time series
Using the risk premia build up approach, what are the 4 components to predicting fixed income discount rates
Nominal rate
Maturity premium
Liquidity premium
Credit premium
Add them up and that is your discount rate
Imagine you use the risk premia build up approach to forecast fixed income discount rate/ytm.
Lets image your estimate comes to 5%, but the market is pricing it a 4% - buy the security or not?
DO NOT BUY IT. You should be compensated at 5% for that level of risk, so do not buy it
Grinold Kroner Model - show formula
Dividend Yield + Exepcted Inflation + Expected Earnings growth - (change in outstanding shares) + change in PE ratio
In the Grinold kroner model, what is the INCOME return?
The divident yield and the change in outstanding shares (EXPECTED)
In the Grinold kroner model, what is the Earning return?I
EXPECTED The earnings + inflation
In the Grinold kroner model, what is the Price return?
Change in PE
THe Singer Taheer Model - what is the formula (2 formulas)
(Correlation * SD )+(Sharpe Ratio) -> Integrated markets
(1 * SD )+(Sharpe Ratio) -> Segmented markets
This is the RISK premium of each type of market
How would increasing interest rates or vacancies effect the cap rate on real estate valuation
it would DECREASE it - becaise the G function in (r-g) would increase
Real estate risk premiums
Term (maturity)
Liquidity
Credit
Equity risk
How should you adjust for smoothing of indicies when valuing or forecasting real estate risk. return
Jack it up. Smoothing indicies will INCREASE return and REDUCE risk, so increase the risk factor and reduce return factor
How are reits correlated with equity index
Positivley over the short term
What are the 3 themes/theories to predict forex movements for capital market expectations
Trade flows
PPP
Portfolio Approach
What is the trade approach to forex predictions in capital market expectatison
Deficits (if unsustainable) will depreciate a currency
PPP - what is it and how does it effect FOREX
it is the effect of inflation on well integrated ecnomies.
High inflation will increase nominal rate which will DEPRECIATE that currency
How do restrictions on capital flows effect forex values
Huge restrictions will bias values downward
Capital mobility - how does it effect forex
High mobility will significantly increase value of a currency when investment opporunities increase UNTIL the market realises the value is overcooked and it will revert to the mean
Portfolio approach - strong economic growth will do what to a currency
It will cause inflation, meaning the currency will decrease
Forecasting volatility - what the the 2 approaches and the name of the combination of the 2 approaches
Sample (using historic, unbias and consistent data to punt on future values_
Factor/Target - stratified sampling (bias and inconsistent)
Sample (times weight) + Target (Time weight) = Shrinkage volatility.
Reduces the effect of outliers in sample data, Great for SMALL data set
What is volatility clustering
High vol will be followed by high vol periods and VISE VERSA
What is the equity risk premium
Equity r - 10 yr treasury
Grwth rate of RE formula
Cap rate + growth of NOI - change in noi %
