Abstract
In principle the gilt–equity yield ratio (GEYR) can be used as a decision criterion for choosing between equity and bonds because it is sensitive to mispricing. However, the GEYR is also influenced by other variables. Consequently, observed movement in the GEYR cannot be confidently attributed to mispricing without controlling for the other variables which might cause the GEYR to vary. This paper demonstrates that the GEYR can be used as a signal to switch profitably between equity and bonds provided that the GEYR threshold value indicating a profitable switch is adjusted to incorporate changes in variables such as expected inflation and the equity risk premium. Simple empirical experiments are carried out aimed at evaluating how well the GEYR performs as a trading rule.
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