Board of Governors of the Federal Reserve System (US)
Finance and Economics Discussion Series
The Decline in Asset Return Predictability and Macroeconomic Volatility
We document strong U.S. stock and bond return predictability from several macroeconomic volatility series before 1982, and a significant decline in this predictability during the Great Moderation. These findings are robust to alternative empirical specifications and out-of-sample tests. We explore the predictability decline using a model that incorporates monetary policy and shocks with time-varying volatility. The decline is consistent with changes in both policy and shock dynamics. While an increase in the response to inflation in the interest-rate policy rule decreases volatility, more persistent and less volatile shocks explain the lower predictability.
Cite this item
Alex Hsu & Francisco J. Palomino & Charles Qian, The Decline in Asset Return Predictability and Macroeconomic Volatility, Board of Governors of the Federal Reserve System (US), Finance and Economics Discussion Series 2017-050, May 2017.
- E14 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Austrian; Evolutionary; Institutional
- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
Keywords: Asset return predictability ; Great Moderation ; Monetary policy ; Time-varying macroeconomic volatility
This item with handle RePEc:fip:fedgfe:2017-50
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