Fed model

equity market valuation, p 156, example 8

-difference, on average, is 0.70

now on p . 159, example 10 part 1

-difference is 0.40, indicating it’s undervalued. however, because the historical average difference is 0.70, the smaller difference of 0.40 --> overvalued.

my question is, then, on the exam, let’s say there was a question where we had to calculate the yield difference to see if equities are undervalued/overvalued. would we have to keep the historical average (0.70) in mind and compare it to the calculated answer to see if they’re undervalued or not?


No, if they provide the historical average of difference in yield we use that as B/M to discern whether over/under valued.

If not stated otherwise, we would believe that both yield should be equal for equities to be fairly valued.