Towards a Better Fed Model

Abstract

We present an alternative to the widely known and much-maligned model. The proposed alternative makes a coherent comparison between equities and bonds that eliminates the theoretical and empirical flaws of the original (as well as any need for ad hoc asset-class volatility adjustments). The output of the model is a time-series value factor, which is then used to develop a tactical asset allocation strategy. Historical simulations suggest the resulting strategy is superior not only to the original Fed model, but to tactical strategies based on other popular time-series value factors as well. Beyond its forecasting and tactical allocation performance, the proposed model also provides significant insight into equity market dynamics--insight that has been validated by recent historical events.