A unified mapping between the real economy and financial markets.

I have long been a curator of macro-financial market interactions.  I even started writing a book on the topic (for my past research see my personal website). One year ago, I began to seriously consider and map out a general theory of financial markets.  I use "map" because the real economy maps to asset prices and vice-versa.  Understanding the roads that bind these systems is unquestionably important for any macro asset manager.
My journey led me to combine expectations, financial market prices and the real economy, into a set of roughly tautological equivalences with corresponding deviations representing investment opportunities (risk premiums included).  My thoughts fill the pages of a series of notebooks that are currently in a storage unit ten hours south in Richmond, VA.  Nevertheless, I feel compelled to reconstruct and disseminate my ideas from memory.

I use past expectations and realized values to reflect the financial and real economic incentives faced by institutions and households.   My model does not require forward looking expectations to explain or forecast the future - all that is required are past expectations.  This is in stark contrast to many modern macro-finance models which require the use of expected future values for forecasting.

I define financial incentives as incentives created by past and present financial conditions.  Economic incentives are created by the economic position of society today relative to recent past.  Financial and economic incentives are often correlated in time.

For my basic model construction please see the appendix to this paper (starting on page 54). I will attempt to be more thorough in future blog posts, but time is scant per usual.


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