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Report
Characteristic-Sorted Portfolios: Estimation and Inference
Portfolio sorting is ubiquitous in the empirical finance literature, where it has been widely used to identify pricing anomalies. Despite its popularity, little attention has been paid to the statistical properties of the procedure. We develop a general framework for portfolio sorting by casting it as a nonparametric estimator. We present valid asymptotic inference methods, and a valid mean square error expansion of the estimator leading to an optimal choice for the number of portfolios. In practical settings, the optimal choice may be much larger than standard choices of five or ten. To ...
Discussion Paper
Skills Mismatch, Construction Workers and the Labor Market
Recessions and recoveries typically have been times of substantial reallocation in the economy and the labor market, and the current cycle does not appear to be an exception. The speed and smoothness of reallocation depend in part on the structure of the labor market, particularly the degree of mismatch between the characteristics of available workers and newly available jobs. Such mismatches could occur because of differences in skills between workers and jobs (skills mismatch) or because of differences in the location of the available jobs and available workers (geographic mismatch). In ...
Report
Fundamental disagreement
We use the term structure of disagreement of professional forecasters to document a novel set of facts: (1) forecasters disagree at all horizons, including the long run; (2) the term structure of disagreement differs markedly across variables: it is downward sloping for real output growth, relatively flat for inflation, and upward sloping for the federal funds rate; (3) disagreement is time-varying at all horizons, including the long run. These new facts present a challenge to benchmark models of expectation formation based on informational frictions. We show that these models require two ...
Report
Deconstructing the yield curve
We investigate the factor structure of the term structure of interest rates and argue that characterizing the minimal dimension of the data generating process is more challenging than currently appreciated. As a result, inference procedures for yield curve models that commit to a parsimoniously parameterized factor structure may be omitting important information about the underlying true factor space. To circumvent these difficulties, we introduce a novel nonparametric bootstrap that is robust to general forms of time and cross-sectional dependence and conditional heteroskedasticity of ...
Working Paper
Unemployment Rate Benchmarks
This paper discusses various concepts of unemployment rate benchmarks that are frequently used by policymakers for assessing the current state of the economy as it relates to the pursuit of both price stability and maximum employment. In particular, we propose two broad categories of unemployment rate benchmarks: (1) a longer-run unemployment rate expected to prevail after adjusting to business cycle shocks and (2) a stable-price unemployment rate tied to inflationary pressures. We describes how various existing measures used as benchmark rates fit within this taxonomy with the goal of ...
Report
Changing risk-return profiles
We show that realized volatility, especially the realized volatility of financial sector stock returns, has strong predictive content for the future distribution of market returns. This is a robust feature of the last century of U.S. data and, most importantly, can be exploited in real time. Current realized volatility has the most information content on the uncertainty of future returns, whereas it has only limited content about the location of the future return distribution. When volatility is low, the predicted distribution of returns is less dispersed and probabilistic forecasts are ...
Report
On binscatter
Binscatter, or a binned scatter plot, is a very popular tool in applied microeconomics. It provides a flexible, yet parsimonious way of visualizing and summarizing mean, quantile, and other nonparametric regression functions in large data sets. It is also often used for informal evaluation of substantive hypotheses such as linearity or monotonicity of the unknown function. This paper presents a foundational econometric analysis of binscatter, offering an array of theoretical and practical results that aid both understanding current practices (that is, their validity or lack thereof) as well ...
Discussion Paper
Forecasting Interest Rates over the Long Run
In a previous post, we showed how market rates on U.S. Treasuries violate the expectations hypothesis because of time-varying risk premia. In this post, we provide evidence that term structure models have outperformed direct market-based measures in forecasting interest rates. This suggests that term structure models can play a role in long-run planning for public policy objectives such as assessing the viability of Social Security.
Discussion Paper
Preparing for Takeoff? Professional Forecasters and the June 2013 FOMC Meeting
Following the June 18-19 Federal Open Market Committee (FOMC) meeting different measures of short-term interest rates increased notably. In the chart below, we plot two such measures: the two-year Treasury yield and the one-year overnight indexed swap (OIS) forward rate, one year in the future. The vertical line indicates the final day of the June FOMC meeting. To what extent did this rise in rates following the June FOMC meeting reflect a shift in the expected future path of the federal funds rate (FFR)? Market participants and policy makers often directly read the expected path from ...
Discussion Paper
Discounting the Long-Run
Expectations about the path of interest rates matter for many economic decisions. Three sources for obtaining information about such expectations are available. The first is extrapolation from historical data. The second consists of surveys of expectations. The third are expectations drawn from financial market prices, often referred to as market expectations. The last are usually considered to be model-based expectations, because, generally, a model is needed to reliably extract expectations from current prices. In this post, we explain the need for and usage of term structure models for ...