Search Results
Working Paper
Asset allocation under multivariate regime switching
This paper studies asset allocation decisions in the presence of regime switching in asset returns. We find evidence that four separate regimes - characterized as crash, slow growth, bull and recovery states - are required to capture the joint distribution of stock and bond returns. Optimal asset allocations vary considerably across these states and change over time as investors revise their estimates of the state probabilities. In the crash state, buy-and-hold investors allocate more of their portfolio to stocks the longer their investment horizon, while the optimal allocation to stocks ...
Working Paper
Predictable dynamics in the S&P 500 index options implied volatility surface
One key stylized fact in the empirical option pricing literature is the existence of an implied volatility surface (IVS). The usual approach consists of fitting a linear model linking the implied volatility to the time to maturity and the moneyness, for each cross section of options data. However, recent empirical evidence suggests that the parameters characterizing the IVS change over time. In this paper we study whether the resulting predictability patterns in the IVS coefficients may be exploited in practice. We propose a two-stage approach to modeling and forecasting the S&P 500 index ...
Working Paper
Mildly Explosive Dynamics in U.S. Fixed Income Markets
We use a recently developed right-tail variation of the Augmented Dickey-Fuller unit root test to identify and date-stamp periods of mildly explosive behavior in the weekly time series of seven U.S. fixed income yield spreads between September 2002 and January 2015. We find statistically significant evidence of such behavior in six of these spreads. Mild explosivity migrates from short-term funding markets to more volatile medium- and long-term markets during the Great Financial Crisis. For some markets, we statistically validate the conjecture, originally suggested by Gorton (2009a,b), that ...
Journal Article
No volatility, no forecasting power for the term spread
Journal Article
Is the bond market irrational?
Working Paper
Home bias and high turnover in an overlapping generations model with learning
This paper develops a two-country OLG model under the assumption that investors are on a Bayesian learning path. While investors from both countries receive identical information flows, domestic investors start off with less precise prior beliefs concerning foreign fundamentals. On a learning path, differences in beliefs and estimation risk generate portfolio biases similar to those observed empirically: home bias in equity portfolios and trend-chasing in international flows. In addition, due to the higher volatility of the estimates of foreign state variables, our model produces excessive ...
Working Paper
Term structure of risk under alternative econometric specifications
This paper characterizes the term structure of risk measures such as Value at Risk (VaR) and expected shortfall under different econometric approaches including multivariate regime switching, GARCH-in-mean models with student-t errors, two-component GARCH models and a non-parametric bootstrap. We show how to derive the risk measures for each of these models and document large variations in term structures across econometric specifications. An out-of-sample forecasting experiment applied to stock, bond and cash portfolios suggests that the best model is asset- and horizon specific but that the ...
Journal Article
Is the financial crisis over? a yield spread perspective
Our finding is consistent with some recent, substantial volatility in the U.S. corporate bond market and leaves open a possibility that additional, future shocks to default premia may have long-lived effects.
Working Paper
An econometric model of nonlinear dynamics in the joint distribution of stock and bond returns
This paper considers a variety of econometric models for the joint distribution of US stock and bond returns in the presence of regime switching dynamics. While simple two- or three-state models capture the univariate dynamics in bond and stock returns, a more complicated four state model with regimes characterized as crash, slow growth, bull and recovery states is required to capture their joint distribution. The transition probability matrix of this model has a very particular form. Exits from the crash state are almost always to the recovery state and occur with close to 50 percent chance ...
Working Paper
International asset allocation under regime switching, skew and kurtosis preferences
This paper proposes a new tractable approach to solving asset allocation problems in situations with a large number of risky assets which pose problems for standard approaches. Investor preferences are assumed to be defined over moments of the wealth distribution such as its mean, variance, skew and kurtosis. Time-variations in investment opportunities are represented by a flexible regime switching process. In the context of a four-moment international CAPM specification that relates stock returns in five regions to returns on a global market portfolio, we find evidence of distinct bull and ...