What the hell is Ibbotson-Chen?

I don’t think it’ll be all that relevant either. In any case it’s in Schweser Session 10 | Reading 35 | LOS c and belongs to Valuation Concepts/Return Concepts/Macroeconomic model estimates.
I just read it. Suppose:-
i is inflation, E = 2.5%
g track the growth in GDP, E[g] = 3%
PE-g reflects growth in P/E, reflects over/under-valuation, E[PE-g] = 0%
E[Income] = 2.2% based on S&P 500 expected dividend yields 2.1% & 0.1 reinvestment return
Rf is risk-free rate, suppose it is 5%. Re is equity risk premium (the unknown variable).
Ibbotson et al has developed a formula:
Re + Rf = (1+i)(1+g)(1+PE-g) - 1 + Income
Plugging:
Re + 5% = 1.025 * 1.03 * 1.00 - 1 + 0.022 >> Re = 0.277
This is in short what the section states. It also says that macroeconomic models are “more reliable when public equity represent a relatively large share of the economy”.
This is contrasted to the Gordon Growth model based on a consensus long-term growth rate, current long-term gov. bond yield & dividends on some broad equity index. If you apply Gordon on macro variables rather than analysts’ consensus it seems to be called a supply side model…
 
Stalla covered it briefly… and Schweser may not mention in the notes, but they test it in a mock exam.
Stalla dropped the ball on one formula - FCFE given target capital structure. I’ve never seen the forumal before, but it showed up in the CFAi Mock. Actually that’s a lie, I briefly glanced over it in Secret Sauce, but thought it was obscure and would not be tested.
 
that formula is
NI - ((1-DR) (FCInv - Dep) - (1-DR)(NWCInv)
where
DR = Debt to Asset ratio
correct me if im wrong
 
AKA : Supply side model. One of four listed ways to determine the equity risk premium. You have historical, forward looking (GGM), Supply side and survey estimates. Ib-Chen is the third.
 
If LOS 35.c is indeed the relevant LOS, what jumps out at me is the absence of the word “calculate.”
 
This was that model that EVERYONE I spoke to including the instructor of my L2 Class said that will not show up “if that shows up you won’t have to calculate”. I wrote it on my formula sheet in February and punted on it based on their view.
 
was it a schweser class? i just got their post-exam survey and let them have a piece of my mind, far too many major issues with the material this year, and lack of substance, question format etc… ugh
 
So I’m scanning headlines today and *instantly* stopped at one name - Ibbotson.
This Mr. Ibbotson is kind of a big deal -
http://www.thestreet.com/story/10781836/1/stock-market-brainiac-starts-h...
and Chen? he’s not far behind…
How is it possible to feel smarter and dumber at the same time? Here are two totally relevant modern finance gurus that I know nothing about. Now I know a bit more (thanks CFA) but I feel totally ignorant for not paying attention the first time around - like on the pages of the CFAI curriculum!
Just drives home the point of using the curriculum. If you look at the authors of some of the readings, there are some very well-respected contributors. Is it crazy that I want to go back to some of the sections *now* when I actually have time? Most likely I’ll enjoy it in the absence of test pressure and sleep deprivation.
It’s impossible to remember EVERYTHING that we read in the curriculum. But learning isn’t about memorization…it’s about having the curiosity to seek out things that we want to know more about, and when things start to click it’s a beautiful thing! Another beautiful thing? Passing the exams. Sigh…
 
These guys are a big deal. And they live forever!
The other week, my buddy goes “do you know who that is in the conference room?”
“No.”
“Bill Sharpe…as in the Sharpe Ratio and CAPM!”
Didn’t get an autograph…
 
You must log in or register to reply here.
Back
Top