Forecasting Asset class return 1 Flashcards
Formal Tools of forecasting FI return
(1) Statistical Methods
(2) Discounted Cash Flow Models (based on CF)
(3) Risk Premium Models (build up, CAPM)
statistical method of forecasting return
+ Well-known Sample Statistics
+ Shrinkage Estimation
+ Time-series estimation
the reason Realized return may # YTM
+ Sell bond prior to maturity
+ Reinvesent risk: Rising (Falling) interest rate
part in risk premium
+ Short-term Default Free Rate
+ Term Premium
+ Credit Premium
+ Liquidity Premium
method for determine Short-term Default Free Rate
+ Government zero-coupon yield
+ Central bank policy rate
+ Future short-term rate
+ Future policy rates
+ Quantitative models (Taylor rule)
Main drivers of Term Premium in fixed income
+ Level-dependent inflation uncertainty
+ Ability to hedge recession risk
+ Supply and Demand
+ Cyclical Effects
base forecasts on other indicators of term premium
+ Ex ante real yield
+ Cochrane and Piazzesi curve factor
+ Kim and Wright premium
+ Slope of the yield curve
+ Supply indicator (share of >10-year debt)
+ Cyclical Proxies (Corp Profit/GDP, Business confidence,
unemployment rate)
Driven of credit premium
credit quality
Credit Premium compensate for ?
level of losses and risk of default losses
additional factor of emerging market bond
(1) Economic Risks/Ability to Pay
(2) Political and Legal Risks/Willingness to pay
methods for forecasting equity returns by historical approach
+ historical mean return
+ Shrinkage
DCF approach of forecasting equity returns
+ Gordon growth model
+ Grinord Kroner model
method for forecasting equity returns
(1) Historical return
(2) DCF method
(3) Risk premium approach
Equilibrium approach
(1) ICAPM
(2) Singer and Terhaar
Singer and Tehaar function
ERP = Degree of Integration * ERP (full Integration) +
(1-Degree of Integration) * ERP (full segmentation)
method for forecasting real estate returns
(1) Historical real estate return
(2) Real estate cycle
(3) Capitalization rate
(4) Risk premium on real estate
(5) Real estate in equilibrium
Cap rate method for real estate return
E= Cap rate+ NOI growth rate
risk premium of real estate return
+ Term premium
+ Credit premium
+ Equity risk premium
+ Liquidity premium
forecast exchange rate
+ Focus on Goods & Services, Trade, current account
+ Focus on Capital Flow
5 method of forecasting volatility
(1) Sample Statistics: Constant VCV Matrix with Sample Statistics
(2) Multi- Factor Models: VCV Matrices from Multi- Factor Models
(3) Shrinkage Estimation: of VCV Matrices
(4) Smoothed Returns: Estimate Volatility from Smoothed Returns
(5) ARCH Models
Fully integrated risk premium
RPGi = βi x RP = ρi x σi x (RPGM / σGM) = ρi x σi x Sharpe ratio global
Fully segmented risk premium:
RPSi= 1×RP = 1 × σi x (RP / σi)
VCV Matrix
variance-covariance matrix
risk premium for asset
= beta x std deviation x Sharpe ratio
method to determine whether an expected yield change will generate positive or negative returns
analysis of the YTM and Macaulay Duration
3 risk premium in The risk premium approach
(1) term premium,
(2) credit premium
(3) liquidity premium
6 characteristics of bonds have highest liquidity
(1) issued at close to par or market rates,
(2) new
(3) large in size
(4) issued by a frequent and well-known issuer,
(5) simple in structure
(6) high credit quality
liquidity premium
= the highest quality issuer (sovereign) - the next highest quality issuer (sovereign)
5 Indicators of heightened credit risk in emerging market bonds
(1) Deficit / GDP > 4%
(2) Debt / GDP > 70%
(3) real growth rate < 4%
(4) Foreign debt > 50% GDP and > 200% current account
(5) foreign exchange reserve < 100% short term debt
Grinold-Kroner model
expected equity return =
(1) Expected CF return (dividend yield - change in share outstanding)
(2) Nominal earning growth (read earning growth + inflation)
(3) Expected repricing return (change in P/E ratio)
Boom and Bust in business cycle movements
(1) boom: higher demand -> up property values
(2) bust: falling demand -> down property values and lease rates down
Shrinkage Estimates
suppose that:
+ the sample covariance: 180
+ the target (from a factor-based model) estimated covariance: 220.
If the analyst weights the historical covariance by 60% and the target by 40%, the shrinkage estimate would be 196 (= 180 × 0.60 + 220 × 0.40)
Smoothed Returns
+) Rt, is a weighted average of the current true return, rt, and the previous observed return: Rt = (1 - y) rt + yx R(t-1)
+) var(r) = (1+y)/(1-y) x Var(R)`
informal Tools of forecasting FI return
(1) Survey: ask expert for opinion
(2) Judgment: qualitative synthesis of information derived from various sources and filtered through the lens of experience
Well-known Sample Statistics
use
+ sample means,
+ variances, and
+ correlations,
to describe the distribution of future returns
Time-series estimation
+ base on lagged value
+ normally used to estimate near term volatility
method for FORECASTING FIXED INCOME RETURNS
(1) discounted cash
(2) risk premium approach
(3) equilibrium model
other indicators for term premium of Fixed income
(1) Ex ante real yield
(2) Cochrane and Piazzesi curve factor
(3) Kim and Wright premium
(4) Slope of the yield curve
(5) Supply indicator (share of >10-year debt)
(6) Cyclical Proxies (Corp Profit/GDP, Business confidence,
unemployment rate)
Indicators to predict excess returns (US investment-grade Corp bond to T-bills)
(1) Coporate OAS
(2) Equity Volatility
(3) Yield curve slope (10yr - 2yr)
why credit premium higher at short-term ?
(1) Event risk
(2) illiquidity
full integration
+ use when market is integrated markets, capital flows freely
+ Function: RP = (std deviation) x (Sharpe ration of Global market) x (cor to global market)
Full segmentation
+ When markets are segmented, capital does not freely across borders
+ Function: RP = (std deviation) x (Sharpe ration of Global market)
+ RP of full segmentation > RP of full integration
Indivisibility
characteristics of real estate, mean can not devide
4 Problem from characteristic of real estate asset
(1) Heterogeneity
(2) Indivisibility
(3) InMobility
(4) Illiquidity
REIT like ? in short - long term
short term: like equity
long term: like real estate
mechanics trade in good & service affect exchange rate
trao đổi -> tao phải có
(1) trade flow (import - export) (large trade without financed -> likely crisis)
(2) purchasing power parity
(3) competitiveness and sustainability of the current account
3 implication to look at of capital flow affect exchange rate
(1) Capital mobility -> 3 phases:
(1.1) the exchange rate will initially significantly appreciate
(1.2) following an extended level of stronger exchange rates in the
intermediate term, investors will start to expect a reversal
(1.3) the exchange rate in the long run will tend to start reverting (depreciate) once the investment opportunities have been realized
(2) Uncovered interest rate parity :
+ Delta E = Delta R nominal
+ Hot money problem
(3) Portfolio balance and composition: strong econs => increase currency share to global market portfolio => weak currency must need premium.
hot money problems related to Money policy
(1) central banks’ ability to use monetary policy effectively is limited
(2) firm use short term to finance long term => increase market risk
(3) exchange rates tend to overshoot, creating business disruption
mitigate to risk premium of weak currency
(1) Investors tend to have a strong home country bias, which leads them to
absorb (hap thu) a larger share of the new assets
(2) If growth is due to productivity gains, investors may fund it with financial flow + FDI (dau tu do gia nhan cong re)
(3) Countries that experience high trend rates tend to be smaller, emerging
markets. Increasing the weight in these countries generally does not weaken
their currency
2 mitigate to weaken exchange rate by large account deficit
(1) Current account deficit is easy to finance if it profitable
(2) Small current account deficits in global reserve currencies,provide global liquidity and are beneficial to financial system
Time-series estimators
which explicitly incorporate dynamics, may summarize historical data well without providing insight into the underlying drivers of forecasts
two main problems with using the sample VCV matrix
(1) It cannot be used for large numbers of asset classes
(2) it is subject to substantial sampling error
Adv & Disadv of factor-based model (linear factor model) impose structure to VCV Matrix
Adv: allows to handle very large numbers of asset classes
Disadv: biased and inconsistent unless the assumed structure is true
hot money flow (definition and impact)
huge flows of capital in response to interest rate differentials
+ Impact:
(1) limit the central bank’s ability to run an effective monetary policy
(2) encourage firms to fund longer-term needs with short-term money
(3) inevitable overshooting of the exchange rate is likely to disrupt non-financial businesses.
+ Solution: sterilize the impact: selling/buying gov securities
Uncovered interest parity
+ the expected percentage change in the exchange rate should be equal to the nominal interest rate differential
+ carry trades tend to be profitable on average,
and UIP does not hold up well as a predictor of exchange rates
In short term, REIT like…, in long term, REIT like….
(1) Stock
(2) direct real estate
The long-run, steady-state NOI growth rate for commercial real estate as a whole should be ……. the growth rate of GDP
close
in emerging market, in crisis, tend to experience capital outflow
A. correct
B. Incorrect
B. incorrect because:
. Emerging markets tend to be more
segmented than developed markets. When markets are segmented, capital does not flow freely across borders.
what is assumption of fully intergration
allows the use of a single global market portfolio to determine equity-versus-bills risk premiums for all assets
what is assumption of segmentation of markets
each asset class in each country is priced without regard to any other country/asset class
Time horizon < Maccaulay Duration. What is dominant ?
Price risk is dominant
Time horizon > Macaulay Duration
What is dominant ?
Reinvestment risk is dominant
when forecast FI return = building block, how can forecast if ST interest rate negative ?
(1) use nomalize
(2) use Taylor rule
Grinold Kroner Model
Expected return = Expected Income Return + Expected Nominal Growth in Earningsm+ Expected Repricing Return
expected CF return
= D/P - Delta S
