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Working Paper
Market timing strategies that worked
In this paper, we present a few simple market-timing strategies that appear to outperform the "buy-and-hold" strategy, with real-time data from 1970 to 2000. Our focus is on spreads between the E/P ratio of the S&P 500 index and interest rates. Extremely low spreads, as compared to their historical ranges, appear to predict higher frequencies of subsequent market downturns in monthly data. We construct "horse races" between switching strategies based on extremely low spreads and the market index. Switching strategies call for investing in the stock market index unless spreads are lower ...
Journal Article
How important is the inflation risk premium?
Investors and market analysts generally believe that the yield on a nominal bond includes an inflation risk premium to compensate investors for bearing the inflation risk associated with the bond. Knowing how much of a risk premium investors require on nominal bonds can be valuable information for policymakers. For government Treasuries, the size of the risk premium represents the potential interest savings for governments when nominal securities are replaced with real, or inflation-indexed, securities. And, because the inflation risk premium reflects perceived inflation uncertainty, changes ...
Journal Article
Liquidity risk premia and breakeven inflation rates
In recent years, monetary policymakers have monitored several measures of market expectations of future inflation. One of these measures is based on the yield differential between nominal and inflation indexed Treasury securities. This yield spread is also called the ?breakeven inflation rate.? An increase in the breakeven rate is sometimes viewed as a sign that market inflation expectations may be on the rise. For example, the FOMC frequently refers to the yield spread as a measure of ?inflation compensation? and considers the yield spread an indicator of inflation expectations in policy ...
Journal Article
Can TIPS help identify long-term inflation expectations?
Investors and policymakers have long hoped that Treasury Inflation Protected Securities (TIPS) would provide an accurate measure of long-term market inflation expectations. To make informed decisions and to ensure that inflation does not erode the purchasing power of their assets, investors need to assess the rate of inflation expected by other market participants. Having an accurate measure of market inflation expectations can also help policymakers assess their effectiveness in controlling long-term inflation, as well as their credibility among market participants.> Until recently, however, ...
Working Paper
Do the spreads between the E/P ratio and interest rates contain information on future equity market movements?
We examine the usefulness of the spreads between the e/p ratio of the S&P 500 index and the yields on 3-month and 10-year Treasury securities as indicators of future market conditions. We find that while spreads are not particularly useful in a regression framework, the extreme values of the spreads do contain information on the market outlook. Specifically, for the period of 1967 to 1997, portfolios that only invested in the stock index when the spreads were above their historical tenth percentile levels produced higher average returns (not statistically significant) and lower variances ...
Journal Article
Settlement risk in large-value payments systems
The phenomenal growth of financial market and trading activities worldwide has led to tremendous growth in large-value payments systems. Large-value payments systems are the electronic banks used to transfer large payments among themselves. Payment orders processed in such systems in the United States, for example, are typically well above $1 million. ; The tremendous growth of payments system use throughout the world has increased both the possibility of settlement failures and the potential impact of such failures. In 1996, the average turnover in a single day exceeded the combined capital ...
Journal Article
Features and risks of Treasury Inflation Protection Securities
In 1997, the U.S. Treasury began the quarterly issuance of inflation indexed bonds, called Treasury Inflation Protection Securities (TIPS). So far, the Treasury has issued both 5-year and 10-year indexed bonds and will begin to issue 30-year indexed bonds and inflation indexed savings bonds in 1998. TIPS differ from conventional Treasury bonds in both their payment flows and risks. With virtually no inflation risk, they are the safest assets currently available in the U.S. market. Combined with conventional Treasury bonds, they allow investors to separate inflation risk from real interest ...
Journal Article
Why has the nonfinancial commercial paper market shrunk recently?
The total volume of nonfinancial commercial paper outstanding peaked in the fall of 2000 and has declined rapidly ever since. By September 2002, the market had shrunk more than 50 percent. Relative to historical patterns, both the magnitude and the timing of the decline are unusual. The decline is the largest on record, and the market started to shrink before the recent recession began. In the past, the volume of commercial paper outstanding tended to increase during the early stages of recessions. ; Commercial paper is an important source of external funding for corporate borrowers and has ...