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Working Paper
Breathing room for beta
This paper argues that a test of beta insignificance, commonly used in empirical studies of the CAPM, predisposes studies toward rejecting the CAPM. Under the null hypothesis of these tests, the CAPM is false. Consequently, insufficient evidence to reject the null is taken as sufficient evidence to reject the CAPM. Simulations suggest that this framework typically leads to false rejection rates of more than 1/2. An alternative test, with a null hypothesis consistent with the CAPM, is proposed. Based on statistics from published studies, the proposed test does not reject the CAPM.
Journal Article
The P/E ratio and stock market performance
The U.S, stock market entered 2000 with five consecutive years of exceptional gains. The S&P 500 index gained more than 18 percent each of these five years, and its value tripled since 1995.> Concern has arisen recently that the stock market may be headed for a downturn because firms' share prices have become very high relative to their earnings. Analysts who hold this view point out that, in the past, high price-earnings ratios have usually been followed by slow growth in stock prices. Other analysts argue that history is no longer a true guide because fundamental changes in the economy have ...
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 ...
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
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
How long is a long-term investment?
Conventional wisdom tells us that stocks tend to outperform government bonds in the long term. That is, if stocks are held long enough, they are usually better investments because their total return is likely to be higher than the return on bonds. While this view may be correct in principle, in practice a crucial question remains: How long is long enough? The answer is important to every investor, not just the wealthy few. With employers relying increasingly on defined-contribution retirement plans, employees must make their own saving and investment decisions. ; Shen reviews historical ...
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 ...
Journal Article
Benefits and limitations of inflation indexed Treasury bonds
In recent years, members of Congress and academia have repeatedly urged the U.S. Treasury to issue some portion of its debt in the form of inflation indexed bonds. With an indexed bond, the interest and maturity value are adjusted by the rate of inflation over the life of the bond. Because the cash flow of an indexed bond is adjusted for inflation, the bond's real value does not vary with inflation, protecting investors and issuers alike from inflation risk.> Inflation indexed bonds would be a fundamental innovation in U.S. financial markets, providing benefits to investors, the Treasury, and ...
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 ...
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 ...