Grinold and Kroner Model

The Grinold and Kroner Model is used to calculate expected returns for a stock, stock index or the market as whole. It is a part of a larger framework for making forecasts about market expectations.

The model states that:

$\mathbb {E} [R]={\frac {\mathrm {Div} _{1}}{P_{0}}}+i+g-\Delta S+\Delta (P/E)$ ^[1]

Where

$\mathbb {E} [R]$ are the expected returns
$\mathrm {Div} _{1}$ is the dividend in next period (period 1 assuming current t=0)
$P_{0}$ is the current price (price at time 0)
$i$ is the expected inflation rate
$g$ is the real growth rate in earnings (note that by adding real growth and inflation, this is basically identical to just adding nominal growth)
$\Delta S$ is the changes in shares outstanding (i.e. increases in shares outstanding decrease expected returns)
$\Delta (P/E)$ is the changes in P/E ratio (positive relationship between changes in P/e and expected returns).

One offshoot of this discounted cash flow analysis is the Fed Model. Under the Fed model, the earnings yield is compared to the 10-year treasury bonds. If the earnings yield is lower than that of the bonds, the investor would shift their money into the less risky T-bonds.

Grinold, Kroner, and Siegel (2011) estimated the inputs to the Grinold and Kroner model and arrived at a then-current equity risk premium estimate between 3.5% and 4%.^[2] The equity risk premium is the difference between the expected total return on a capitalization-weighted stock market index and the yield on a riskless government bond (in this case one with 10 years to maturity).

References

↑ Richard Grinold and Kenneth Kroner, "The Equity Risk Premium," Investment Insights (Barclays Global Investors, July 2002).
↑ Richard Grinold, Kenneth Kroner, and Laurence Siegel, "A Supply Model of the Equity Premium," in B. Hammond, M. Leibowitz, and L. Siegel, eds., Rethinking the Equity Risk Premium, Charlottesville, VA: Research Foundation of CFA Institute, 2011.

This article is issued from Wikipedia. The text is licensed under Creative Commons - Attribution - Sharealike. Additional terms may apply for the media files.