Framework and Macro Considerations Flashcards
Elaborate on the framework and challenges of CME
Asset allocation is the primary determinant of the long run portfolio performance. The focus should not be on accurate forecast of one asset class but rather on internal consistency across asset classes (cross sectional and intertemporal consistency).
Step in the framework to develop CME
1) Specify the set of expectation needed including the time horizon to which they apply.
2) Research the historical record and factor that affect the asset performance
3) Specify the model and their information performance.
4) Determine the best sources of information
5) Interpret the current investment environment using the selected data and method applying experience and judgement
6) Provide the set of expectation needed and document conclusion
7) Monitor the actual outcome and compare against the forecast.
What are the challenges in forecasting ?
Limitation of economic data Data measurement error and biases Limitation of historical estimate Ex post risk can be biased measure of ex ante risk Bias in analysts methods Failure to account for conditional information Misinterpretation of correlation Psychological biases Model uncertainty
What are the causes of exogeneous shock to growth ?
Policy changes New products and technologies Geopolitics Natural disasters Natural resources Financial crisis
Elaborate on the decomposition of GDP growth and issues in forecasting
-Growth from labor input
growth in labor size
growth in labor participation
-Growth from labor productivity
Increase capital input
Increase TFP
Elaborate on anchoring assets returns to trend growth ?
Both theory and empirical evidence suggest that the level of default-free bond yield is linked to the trend rate or real money growth.
Vt = GDPt * St * PE
In the long run the equity valuation is linked to the growth of GDP
Market return = Real GDP +infl + EPS/GDP + PE + Div Yield
Elaborate on high GDP growth and equity return
Studies shows that countries with high economic growth rates do not reliably generate higher equity market returns. A partial explanation is that the higher growth rate was already reflected in market prices. If capital stock is growing rapidly, the rate of return on invested capital may be driven down.
What are the main approaches for forecasting
Econometric modeling
Economic indicators
Checklist Approach
Elaborate on Econometric modeling
- Structural models
- Reduced form models
Econometric models are widely regarded as very useful for stimulating the effects of changes in key variables. It constraints the forecaster to a certain degree of consistency. The may exhibit critical limitation s such as unavailability of key input, data measure error or changes in relationship.
Elaborate on Economic indicators
- LEI (leading economic indicator)
- Diffusion index (how many LEI are pointing up)
Elaborate on Checklist Approach
Flexible but very subjective
Elaborate on business cycles
They can vary both in intensity and duration. Much of the uncertainty that sustain the uncertainty is endogenous (suppliers, employers, creditors, customers, policy makers do not behave as expected). Other sources of uncertainty are exogeneous (tech, Natural disaster, geopolitical events).
Elaborate on the phases of business cycles
Initial recovery Early expansion late expansion slow down contraction
Elaborate on Initial recovery and Early expansion
Initial recovery small cap, EM bonds 6 equities higher corp. yield typically perform well. Stock may rise briskly.
Early expansion: Economy gain some steam. Profits rise rapidly. The stocks trend upward and the yield curve flattens. Longer maturity yield are set to remain stable or rise slightly.
Elaborate on Late expansion
Boom mentality prevails output gap has closed, employment is low, profit strong, wages and inflation are rising. Interest rate rise, equity become volatile but rising cyclical and inflation hedges such as commodities may outperform.
