The Grinold and Kroner Model is used to calculate expected returns for a

stock In finance, stock (also capital stock) consists of all the shares by which ownership of a corporation or company is divided.Longman Business English Dictionary: "stock - ''especially AmE'' one of the shares into which ownership of a company ...

, stock

index Index (or its plural form indices) may refer to: Arts, entertainment, and media Fictional entities * Index (''A Certain Magical Index''), a character in the light novel series ''A Certain Magical Index'' * The Index, an item on a Halo megastru ...

or the market as whole.

Description

The model states that:

= \frac + i + g - \Delta S + \Delta (P/E)

Where

\mathbb

are the expected returns *

\mathrm_1

is the

dividend A dividend is a distribution of profits by a corporation to its shareholders. When a corporation earns a profit or surplus, it is able to pay a portion of the profit as a dividend to shareholders. Any amount not distributed is taken to be re-inv ...

in next period (period 1 assuming current t=0) *

P_0

is the current price (price at time 0) *

i

is the expected inflation rate *

g

is the real growth rate in earnings (note that by adding real growth and inflation, this is basically identical to just adding nominal growth) *

\Delta S

is the changes in shares outstanding (i.e. increases in shares outstanding decrease expected returns) *

\Delta (P/E)

is the changes in P/E ratio (positive relationship between changes in P/e and expected returns) One offshoot of this

discounted cash flow The discounted cash flow (DCF) analysis is a method in finance of valuing a security, project, company, or asset using the concepts of the time value of money. Discounted cash flow analysis is widely used in investment finance, real estate deve ...

analysis is the disputed

Fed model The "Fed model" or "Fed Stock Valuation Model" (FSVM), is a disputed theory of equity valuation that compares the stock market's forward earnings yield to the nominal yield on long-term government bonds, and that the stock market – as a whole ...

, which compares the earnings yield to the nominal 10-year Treasury bond yield. Grinold, Kroner, and Siegel (2011) estimated the inputs to the Grinold and Kroner model and arrived at a then-current equity risk premium estimate between 3.5% and 4%.Richard Grinold, Kenneth Kroner, and Laurence Siegel, "A Supply Model of the Equity Premium," in B. Hammond, M. Leibowitz, and L. Siegel, eds., Rethinking the Equity Risk Premium, Charlottesville, VA: Research Foundation of CFA Institute, 2011. The equity risk premium is the difference between the expected total return on a capitalization-weighted stock market index and the yield on a riskless government bond (in this case one with 10 years to maturity).

References

{{reflist Economics models