CORPORATE LIQUIDITY AND NBER RECESSION ANNOUNCEMENTS

Using announcement memos released by the National Bureau of Economic Research (NBER), we show that corporations increase liquidity during the quarter the NBER announces a peak in the business cycle. This reaction is primarily restricted to memos about peaks in the business cycle, whether it is a preliminary announcement or an official confirmation. Federal Open Market Committee and other monetary policy news, real‐time data releases, and tightening credit conditions do not drive the increase. This finding adds to the precautionary cash holdings literature by suggesting that corporations adjust liquidity not necessarily before recessions, but upon confirmation of a recession.     

Asset Market Participation and Portfolio Choice over the Life‐Cycle

Using error‐free data on life‐cycle portfolio allocations of a large sample of Norwegian households, we document a double adjustment as households age: a rebalancing of the portfolio composition away from stocks as they approach retirement and stock market exit after retirement. When structurally estimating an extended life‐cycle model, the parameter combination that best fits the data is one with a relatively large risk aversion, a small per‐period participation cost, and a yearly probability of a large stock market loss in line with the frequency of stock market crashes in Norway.     

Log Mean-Variance Portfolio Selection Under Regime Switching

In this paper we develop a portfolio selection theory under regime switching means and volatilities. We use log mean-variance as the portfolio selection criteria and, as a result, the theory is made substantially easier to implement than other existing theories. Moreover, the estimated regimes are easy to interpret as one of the regimes corresponds to the business cycle turning points. Finally, we conduct an asset allocation simulation and obtain reasonable results by introducing an idea of switching volatility targets.     

Portfolio rebalancing and the transmission of large-scale asset purchase programs: Evidence from the Euro area

The European Central Bank's large-scale asset purchase program targeted safe assets, but also aimed to impact prices of risky assets. The mechanism for this is the “portfolio rebalancing channel”, where financial institutions’ portfolio decisions impact financial prices more broadly. We examine this mechanism using cross-sectional heterogeneity in how the financial portfolios of different sectors of the European economy were affected around the purchase program. We find evidence of rebalancing. In vulnerable countries, where macroeconomic unbalances and relatively high risk premia remained, we document rebalancing towards riskier securities. In less vulnerable countries, based on granular information for large European banks, we document rebalancing toward bank loans.     

The Regime Switching Portfolios

In this paper we develop a portfolio selection theory under regime switching means and volatilities. We use log mean-variance as the portfolio selection criteria and, as a result, the theory is made substantially easier to implement than other existing theories. Moreover, the estimated regimes are easy to interpret as one of the regimes corresponds to the business cycle turning points. Finally, we conduct an asset allocation simulation and obtain reasonable results by introducing an idea of switching volatility targets.     

Portfolio construction incorporating asymmetric dependence structures: a user's guide

We outline a method of portfolio selection incorporating asymmetric dependency structures using copula functions. Assuming normally distributed marginal returns, we illustrate how asymmetric return correlations affect the efficient frontier and subsequent portfolio performance under a dynamic rebalancing framework. Implementing this methodology within the context of tactically allocating a small set of market indices, we demonstrate several key findings. First, we establish the manner by which the efficient frontier constructed under asymmetric dependence differs from a mean‐variance frontier. By establishing a paper portfolio based on these differences, we find that asymmetric correlation structures do have real economic value. The primary source of this economic value is the ability to better protect portfolio value and reduce the size of any erosion in return relative to the normal portfolio when asymmetric return correlations are accounted for.     

Monetary policy and portfolio rebalancing: Evidence from European equity mutual funds

In this study, we provide empirical evidence on the portfolio rebalancing of European equity mutual funds following both conventional (CMP) and unconventional monetary policies (UMP). We use 1772 equity mutual funds’ portfolio holdings over the period 2002Q4–2016Q4. This level of granularity allows us to characterise the funds’ asset allocation in different portfolio dimensions: the size, style, currency, and domicile of the stocks, and managers’ preferred investment strategies. Using a panel fixed effect estimator, our results support the existence of portfolio rebalancing across equity categories following UMP. European equity mutual funds’ assets are, on average, reallocated towards mid-cap, and core stocks and developing economies, and shifted away from small-cap and value stocks and home as well as developed countries. Furthermore, mutual funds seem to concentrate on their preferred and historical investment strategies. These two results suggest that managers are more willing to invest in safer and familiar stocks following UMP announcements thereby decreasing the risk of asymmetry of information. We finally show that the funds size, returns volatility and expense ratio affect the strength of the rebalancing.     

Cyclical Changes in Firm Volatility

We characterize trends and cycles in the volatility of U.S. firms using a measure that we argue more cleanly captures firm‐specific volatility in sales and earnings growth than standard measures do. While earlier literature has emphasized a trend increase in the volatility of publicly traded firms, we find that a typical publicly traded firm has become more stable. We find that the negative association between firm‐specific volatility and the business cycle is weaker than earlier research based on dispersion measures suggests. We find that during the Great Recession of 2007–2009, firm‐specific volatility increased moderately but never substantially exceeded its sample mean. Our results are inconsistent with the hypothesis that firm‐specific volatility is an important driver of the business cycle, as it theoretically could be through an effect of default risk on credit spreads.     

Discount Rates,Debt Maturity,and the Fiscal Theory

This paper examines how the transmission of government portfolio risk arising from maturity operations depends on the stance of monetary/fiscal policy. Accounting for risk premia in the fiscal theory allows the government portfolio to affect expected inflation, even in a frictionless economy. The effects of maturity rebalancing on expected inflation in the fiscal theory depend directly on the conditional nominal term premium, giving rise to an optimal debt-maturity policy that is state-dependent. In a calibrated macrofinance model, we demonstrate that maturity operations have sizable effects on expected inflation and output through our novel risk transmission mechanism.     

The wealth effects of portfolio rebalancing in emerging equity markets

This paper analyzes the wealth effects of alternative portfolio rebalancing strategies for equity investments in nine emerging markets for the period from 1976 to 1998. The choice of rebalancing intervals has a large effect on wealth accumulation and the geometric mean return. The difference between no rebalancing and semi-annual rebalancing is 5.87 percentage points per year. Surprisingly, semi-annual rebalancing, which was optimal for this data set, was also 2.62 percentage points per year better than monthly rebalancing. Positive first- and second-degree autocorrelation among the monthly returns appears to account for the decrease in returns for rebalancing more frequently than semi-annually.     

Inflation risk premia and the expectations hypothesis

We study the properties of the nominal and real risk premia of the term structure of interest rates. We develop and solve the bond pricing implications of a structural monetary version of a real business cycle model, with taxes and endogenous monetary policy. We show the relation of this model with the class of essentially affine models that incorporate an endogenous state-dependent market price of risk. We characterize and estimate the inflation risk premium and find that over the last 40 years the ten-year inflation risk premium has been has averaged 70 basis points. It is time-varying, ranging from 20 to 140 basis points over the business cycle and its term structure is sharply upward sloping. The inflation risk premium explains 23% (42%) of the time variation in the five (ten)-year forward risk premium and it plays an important role in help explain deviations from the expectations hypothesis of interest rates.     

What determines the stock market's reaction to monetary policy statements?

We find that information communicated through monetary policy statements has important business cycle dependent implications for stock prices. For example, during periods of economic expansion, stocks tend to respond negatively to announcements of higher rates ahead. In recessions, however, we find a strong positive reaction of stocks to seemingly similar signals of future monetary tightening. We provide evidence that the state dependence in the stock market's response is explained by information about the expected equity premium and future corporate cash flows contained in monetary policy statements. We also show state dependence in the average stock returns on days of scheduled FOMC meetings and in the impact of monetary policy statements on stock and bond return volatility.     

Optimal Asset Allocation Over the Business Cycle

Utilizing a broadly diversified portfolio of nine equity and debt assets, we show our portfolio's in-sample Markowitz return/risk profile considerably improved by keying asset proportions to cyclical changes in economic activity. For comparative purposes, we use the same assets in a hypothetical buy-and-hold benchmark portfolio. We find the variance/covariance structure of our portfolio to be considerably altered by the phase of the business cycle, with the diversification benefits enjoyed during expansions substantially diluted during recessions. Thus, cyclical reallocation appears to be more important in maintaining Markowitz efficiency during recessions vis-a-vis expansions. In the latter case we find expansion reallocation producing a 3.53% increase in our portfolio's return-to-risk ratio (relative to a buy-and-hold position), while for recessions optimal reallocation leads to a 79.14% increase.     

Credit crises, money and contractions: An historical view

The relatively infrequent nature of major credit distress events makes an historical approach particularly useful. Using a combination of historical narrative and econometric techniques, we identify major periods of credit distress from 1875 to 2007, examine the extent to which credit distress arises as part of the transmission of monetary policy, and document the subsequent effect on output. Using turning points defined by the Harding-Pagan algorithm, we identify and compare the timing, duration, amplitude and co-movement of cycles in money, credit and output. Regressions show that financial distress events exacerbate business cycle downturns both in the 19th and 20th centuries and that a confluence of such events makes recessions even worse.     

Indexing and Stock Price Efficiency

Indexing has experienced substantial growth over the last two decades because it is an effective way of holding a diversified portfolio while minimizing trading costs and taxes. In this article, we focus on one negative externality of indexing: the effect on the efficiency of stock prices. Based on a sample of large and liquid US stocks, we find that greater indexing leads to less efficient stock prices, as indicated by stronger post‐earnings‐announcement drift and greater deviations of stock prices from the random walk. We conjecture that reduced incentives for information acquisition and arbitrage induced by indexing and passive trading are probably the main causes for degradation in price efficiency.     

Divisia Monetary Aggregates,the Great Ratios,and Classical Money Demand Functions

King et al. ( 1991 ) evaluate the empirical relevance of a class of real business cycle models with permanent productivity shocks by analyzing the stochastic trend properties of postwar U.S. macroeconomic data. They find a common stochastic trend in a three‐variable system that includes output, consumption, and investment, but the explanatory power of the common trend drops significantly when they add money balances and the nominal interest rate. In this paper, we revisit the cointegration tests in the spirit of King et al., using improved monetary aggregates whose construction has been stimulated by the Barnett critique. We show that previous rejections of the balanced growth hypothesis and classical money demand functions can be attributed to mismeasurement of the monetary aggregates.     

PORTFOLIO MANAGEMENT: THE ROLE OF CALIBRATION,SHARPNESS, AND UNCERTAINTY

I evaluate the out‐of‐sample predictability of several major indicators for bull and bear markets in monthly S&P 500 series with three quadratic probability score components: calibration, sharpness, and uncertainty. I find that uncertainty limits the trend characterization and thus provides a new perspective from which to identify bull and bear markets. I also find that sharpness plays a key role in determining portfolio returns. Trading strategies that capitalize on sharpness generate higher Sharpe ratios and portfolio returns. The Aruoba–Diebold–Scotti business conditions index is the most profitable indicator for both medium‐ and long‐term trends.     

Portfolio Returns,Market Volatility,and Seasonality

This paper examines three important issues related to the relationship between stock returns and volatility. First, are Duffee's (1995) findings of the relationship between individual stock returns and volatility valid at the portfolio level? Second, is there a seasonality of the market return volatility? Lastly, do size portfolio returns react symmetrically to the market volatility during business cycles? We find that the market volatility exhibits strong autocorrelation and small size portfolio returns exhibit seasonality. However, this phenomenon is not present in large size portfolios. For the entire sample period of 1962–1995, the highest average monthly volatility occurred in October, followed by November, and then January. Examining the two sub-sample periods, we find that the average market volatility increases by 15.4% in the second sample period of 1980–1995 compared to the first sample period of 1962–1979. During the contraction period, the average market volatility is 60.9% higher than that during the expansion period. Using a binary regression model, we find that size portfolio returns react asymmetrically with the market volatility during business cycles. This paper documents a strongly negative contemporaneous relationship between the size portfolio returns and the market volatility that is consistent with the previous findings at the aggregate level, but is inconsistent with the findings at the individual firm level. In contrast with the previous findings, however, we find an ambiguous relationship between the percentage change in the market volatility and the contemporaneous stock portfolio returns. This ambiguity is attributed to strongly negative contemporaneous and one-month ahead relationships between the market volatility and portfolio returns.

     

MONETARY POLICY INDICATORS AS PREDICTORS OF STOCK RETURNS

We explore the linkage between stock return predictability and the monetary sector by examining alternative proxies for monetary policy. Using two complementary methods, we document that failure to condition on the Fed's broad policy stance causes a substantial understatement in the ability of monetary policy measures to predict returns. Industry analyses suggest that cross‐industry return differences are also linked to changes in monetary conditions, as monetary policy has the strongest (weakest) relation with returns for cyclical (defensive) industries. Overall, we find that monetary conditions have a prominent and systematic relation with future stock returns, even in the presence of business conditions.