Capital Market Expectation - CME

Framework and Macro Considerations

Challenges in Forecast

  1. Limitations to using economic data

    • 数据 revised / rebased

  2. Data measurement errors and biases

    • Transcription errors 抄错了

    • Survivorship bias. The survivorship bias might overestimate returns 如PE知有表现好的时候才公布收益,所以 survivorship bias 高估 return

    • Appraisal data. The higher the frequency of data, the lower the correlation, because data become no smoothy. Lower the correlation, higher the risks 数据频率越高,corr越低(因为assume 高频数据是大幅波动的,所以corr低),则 risk 越低。 Return smoother biases downward the risks

  3. Limitations of historical estimates

    • Regime changes make data non-stationary. 由于 regime changes,造成 data non-stationary

    • Non-stationary make data statistically non-predictable.

    • Long time period & large dataset are preferable. Asynchronous data (high frequency data) underestimate correlation and underestimate risks.

  4. Ex-post (将来) risk as a biased risk measure ex-ante (过去的) risk

    • 站在将来看过去 underestimate the risks and overestimate the potential returns

  5. Biases in Analyst's Methods

    • Data-mining 相关性不代表因果关系

    • Time-period Bias 时间选太长会有 regime changes,太短 asynchronous data会导致 low corr, low risks

    • Avoid Bias:

      1. data has economic basis, 数据有经济含义 ,避免相关性因果关系的问题

      2. Scrutinty 仔细检查 examine and inspect closely and thoroughly

      3. Test relationship with out-of-sample data 用样本外数据建议

  6. Prudence Trap: The prudence trap is the tendency to be cautious when making decisions that could be potentially expensive or damaging to the decision maker’s career.

Economic Growth

Exogenous Shocks (unanticipated)

Factors cause the exogenous shocks

Application 预测 re Equity Return

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By Golden Growth Model: P0=D1reg, we expand that into the whole equity market, that re=D1P0+g

  1. D1P0

D1P0=D1/EPSP0/EPS=Div Payout RatioP/E ratio

  1. gequity

  1. Thus, in the long term

    Long-term: gequity=gnominalGDP=greal+π


    Short-term: gequity=ggdp+ΔS%+ΔP/E%

Business Cycle

Reason of cyclical business activities


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1. Initial Recovery 复苏期

2. Early Expansion 早期成长

3. Late Expansion

4. Slowdown

5. Contraction


Deflation is worst! in that, while asset price decrease (deflation), the balance sheet ends up with negative equity. Borrower cannot repay the interests, then Default!

  1. Default on Debt Obligations

  2. Monetary Policy not working, coz inflation negative drives interest rate negative.

    • QE to stimulste the econ

    • however, QE is working in the U.S. because the state of USD, but normally unable to work in other countries, such as CN and JP

Business CycleInflationEconomic PolicyMarkets
Initial recoveryInitially declining inflationStimulative(1) Short-term rates low or declining; (2) Long-term rates bottoming and bond prices peaking; (3) Stock prices increasing
Early expansionLow inflation and good economic growthBecoming less stimulative(1) Short-term rates increasing; (2) Long-term rates bottoming or increasing with bond prices beginning to decline; (3) Stock prices increasing
Late expansionInflation rate increasingBecoming restrictive(1) Short-term and long-term rates increasing with bond prices declining; (2) Stock prices peaking and volatile
SlowdownInflation continues to accelerateBecoming less restrictive(1) Short-term and long-term rates peaking and then declining with bond prices starting to increase; (2) Stock prices declining
ContractionReal economic activity declining and inflation peakingEasing(1) Short-term and long-term rates declining with bond prices increasing; (2) Stock prices begin to increase later in the recession


Policy Impacts

Monetary Policy

Fiscal Policy

Monetary + Fiscal Policy


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Impacts on Yield Curve

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International Consideration

If Current Account Surplus, => Net Export (export > import), => capital inflow 资本流入(钱流入国内)foreign reserve increase 外储增加, => 用外储USD投资海外资产 => 资本外流 => Capital Account Deficits


If Current Account Deficits, Import > Export, 需要借外汇来进口, Capital Account inflow (Surplus)

Interest Rate/Exchange Rate Linkages



by YT=C+S, so YC=S+T

Thus, NX=SINet Private Saving+TGGovernment Surplus

Peg 一国汇率peg另一国

Text Sample: Eastland currently has a fixed exchange rate pegged to Northland with unrestricted capital flows. Eastland is unable to pursue an independent monetary policy with interest rates in Eastland equal to the interest rates prevailing in Northland (the country to which the currency is pegged). If Eastland allows the exchange rate to float, it will now be able to run an independent monetary policy with interest rates determined in its domestic market.

Forecast Asset Class Return

Fixed Income

DCF Approach


Risk Premium Approach


= Rf + Term Premium + Credit Premium + Liquidity Premium

Equity Return

GK model (DCF) - Supply Side (from the firm side) Grinold and Kroner Model

GGM -> 3 steps -> GK model


Pros and Cons

ST model (risk premium) - Demand Side (from the consumer side) Singer Terhaar Approach

CAPM -> internation CAPM




RP=rirf=ρ σiSRm by SRm=rmrfσm


Sample Text:

Real Estate

illiquidy, heterogeneous (各个不一样), maintenance and operation cost, Appraisals


In level II

V0=NOI1rg => r=NOI1V0+g

We get to the formula by composing three parts

  1. Cap Rate: NOI1V0, 经营带来的 income return, should be current cap rate

  2. gnominal=grealNOI+π

  3. %ΔCapRate repricing, coz Capital Gain=V1V0V0 但是因为 估值上升 即 V 提升带来的 Capital Gain 会使 Captial Rate 在分母的 V 变大。所以 Capital Gain & Capital Rate are negative correlated.

r=CapRate+NOI growth%ΔCapRate

Factors Affecting the Cap Rate


Risk Premium

CF of real estate = 租金 + Cap Gain增值


term premium, credit premium, equilty risk premium (cap gain), liquidity premium


短期像 equity,长期才像 real estate

An estimate of the long-run expected or required return for commercial real estate equals the sum of the capitalisation rate (cap rate) plus the growth rate (constant) of net operating income (NOI).

Expected Required Rate=Cap Rate+NOI

Sample Text: An estimate of the long-run expected or required return for commercial real estate equals the sum of the capitalisation rate (cap rate) plus the growth rate (constant) of net operating income (NOI). Plus the percentage change of NOI.

Expected Required Rate: E(Rre)=Cap Rate+NOINominal%ΔCapRate


Exchange Rate

Current Acount: Three factors

Capital Mobility

by UIP, (e is in d/f) e1e0rdrf, and then add premiums


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Volatility Forecasting

下为 Factor-based VCV





  1. 用历史估计未来, biased

  2. 如果 low liquidity 流动性差,则需要 appraisal ,那么数据要 smoothing

    result in low volatile and low correlation


  3. Volatility Clustering

To overcome those drawbacks, we would use those three methods.

  1. Shrinkage Estimate

    • Shrinkage estimate is the combination of the sample and target (factor-based) 相当于sample 和 factor-based的加权平均

    • 但是 依然 biased

  2. 防止 smoothing,


    • Rt 为市场上可见的 appraisal value

    • rt 为真实值


      As rt and Rt1 are irrelevant, cov0.

      We assume also Var(Rt)=Var(Rt1) that we have same appraisal variance.

      Thus, Var(rt)=1λ2(1λ)2Var(Rt)=1+λ1λVar(Rt)

      • As the coefficient must be greater than 1, Var(rt)>Var(Rt)

      • The greater the λ, the more Var(rt)>>Var(Rt)

      • 意味着smooth的越多,则estimate 的 var 比真实的小的越多

  3. ARCH Autoregressive Condition Heteroskedasticity

    • σt2=γ+ασt12+βηt2

      ηt2 is the unexpected component of return, resulted from the previous period's vol, σt12

      ηt2 is not the error term

    • The error term should be instead, ηt2σt12, which is the eta less the vol from previous period.

    • Then, we reform the formula



      • If β=0, then no shocks, then variance is deterministic

      • Take expectation from both sides,


        the expectation of the error term is zero, and assume E(σt2)=E(σt12) over time, then



        We need 1α+β>1 to make the expectation of var is positive over time