Some historical perspectives on the Bond-Stock Earnings Yield Model for crash prediction around the world

Sebastien Lleo and Bill Ziemba

We provide a historical perspective focusing on Ziemba's experiences and research on the bond-stock earnings yield differential model (BSEYD) starting from when he first used it in Japan in 1988 through to the present in 2014. The model has called many but not all crashes. Those called have high interest rates in long term bonds relative to the trailing earnings to price ratio. In general, when the model is in the danger zone, almost always there will be a crash. The model predicted the crashes in China, Iceland and the US in the 2006-9 period. Iceland had a drop of fully 95%. For the US the call was on June 14, 2007 and the stock market fell 56.8%. A longer term study for the US, Canada, Japan, Germany, and UK shows that over long periods being in the stock market when the bond-stock signal is not in the danger zone and in cash when it is in the danger zone provides a final wealth about double buy and hold for each of these five countries. The best use of the model is for predicting crashes. Finally we compare Shiller's high PE ratio crash model to the BSEYD model for the US market from 1962-2012. While both models add value, the BSEYD model predicts crashes better.

Publication number: 
DP 21
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