Forecast Asset classes Returns Flashcards
What are the 2 main approaches to forecasting ?
- Formal tools
- Survey (Judgement)
Elaborate on Formal tools
Statistical methods
Discounted CF method
Risk premium models
Elaborate on Statistical methods
Statistical sampling (mean-variance and correlation) Shrinkage estimation method Time series using independent variable
Elaborate on Risk premium models
Equilibrium model (CAPM) Factor model Building blocks
Applying DCF to CF
Over horizon shorter than the duration, the capital market gain/loss impact will tend to dominate such that rising rates imply lower return whereas over horizon longer than the duration, the capital gain/losses impact will tend to dominate such that rising rates imply higher returns.
Elaborate on Building blocks approach to FI return
Default risk premium
Term premium
Credit premium
Liquidity premium
Elaborate on on risk in EM
In addition to the common risks, EM face economical (ability to pay) and political risks (willingness to pay). A persistent ratio above 4% is a likely cause for concern, a debt to GDP ratio exceeding 70-80%, is a sign of vulnerability. persistent deficit above 4% indicate lack of competitiveness. Weak property right and legal environment are areas of concerns.
Elaborate on Grinold-Kroner model
E(r) = D/P + (% Δ Earning - %Δ share outs.) + % ΔP/E
than total earnings.
With a minor rearrangement of the equation, the expected return can be divided into three components:
■ Expected cash flow (“income”) return: D/P – %ΔS
■ Expected nominal earnings growth return: %ΔE
■ Expected repricing return: %ΔP/E
Define Term premium
Term prem = Rf bond - Rf bill
Elaborate Equity Premium
Equity Return vs Rf bill (old fashion)
Equity Return vs Rf bond (current trend)
Because of their volatility, these premium are not very useful for predicting.
Compute Singer - Terhaar model
We divide the market into 2
Fully integrated model
Fully segmented model
Bi,M = corr i,M (stdi/sdtM)
If the market is global,
RPi = Corr i,GM * std i (RPGM/ std GM)
If the market is segmented,
RPi = 1* RPi = 1*std i (RPS/std S)
We combine both now:
RP = wRPG + (1-w) RPS
Always add back the Rf rate to arrive at the final Expected return.
Summary of the Singer - Terhaar model
1) compute the integrated approach
corr * vola * share ratio
2) compute the segmented approach
vola * sharpe ratio
3) multiply the approaches with the respective weights
Equity risk in EM
The main risk beside liquidity constraints reside in expropriation, insider dealings, dominant shareholders.
Elaborate on RE return
Historical return in RE tend to suffer from lag reporting, smooth averages and distorted volatility and correlation with the market.
Elaborate on RE cycles
RE are very cyclical, with fixed supply at any point in time. High quality properties have little turnover. Lower quality properties are more subject to the whim of the economy.
