Variance risk premia, asset predictability puzzles, and macroeconomic uncertainty
This paper presents predictability evidence from the difference between implied and expected variances or variance risk premium that: (1) the variance difference measure predicts a significant positive risk premium across equity, bond, and credit markets; (2) the predictability is short-run, in that it peaks around one to four months and dies out as the horizon increases; and (3) such a short-run predictability is complementary to that of the standard predictor variables--P/E ratio, forward spread, and short rate. These findings are potentially justifiable by a general equilibrium model with ...
Forecasting through the rear-view mirror: data revisions and bond return predictability
Real-time macroeconomic data reflect the information available to market participants, whereas final data?containing revisions and released with a delay?overstate the information set available to them. We document that the in-sample and out-of-sample Treasury return predictability is significantly diminished when real-time as opposed to revised macroeconomic data are used. In fact, much of the predictive information in macroeconomic time series is due to the data revision and publication lag components.
Bayesian analysis of stochastic volatility models with Lévy jumps: application to risk analysis
In this paper I analyze a broad class of continuous-time jump diffusion models of asset returns. In the models, stochastic volatility can arise either from a diffusion part, or a jump part, or both. The jump component includes either compound Poisson or Lvy alpha-stable jumps. To be able to estimate the models with latent Lvy alpha-stable jumps, I construct a new Markov chain Monte Carlo algorithm. I estimate all model specifications with S&P500 daily returns. I find that models with Levy alpha-stable jumps perform well in capturing return characteristics if diffusion is a source of ...
On the cross section of conditionally expected stock returns
In this paper, we use macrovariables advocated by recent authors to make out-of-sample forecast for returns on individual stocks and then sort stocks equally into ten portfolios on this proxy of conditionally expected returns. The average returns increase monotonically from the first decile (stocks with the lowest expected returns) to the tenth decile (stocks with the highest expected returns), and the difference between the tenth and first deciles is a significant 4.8 percent per year. While these portfolios pose a challenge to the CAPM, they appear to be explained by Carhart's (1997) ...
Regime shifts in mean-variance efficient frontiers: some international evidence
Regime switching models have been assuming an increasingly central role in financial applications because of their well-known ability to capture the presence of rich non-linear patterns in the joint distribution of asset returns. After reviewing key concepts and technical issues related to specifying, estimating, and using multivariate Markov switching models in financial applications, in this paper we examine how the presence of regimes in means, variances, and covariances of asset returns translates into explicit dynamics of the Markowitz mean-variance frontier. In particular, we show both ...
On forecasting the term structure of credit spreads
Predictions of firm-by-firm term structures of credit spreads based on current spot and forward values can be improved upon by exploiting information contained in the shape of the credit-spread curve. However, the current credit-spread curve is not a sufficient statistic for predicting future credit spreads; the explanatory power can be increased further by exploiting information contained in the shape of the riskless-yield curve. In the presence of credit-spread and riskless factors, other macroeconomic, marketwide, and firm-specific risk variables do not significantly improve predictions of ...
The effect of interest rate options hedging on term-structure dynamics
Market participants and policymakers closely monitor movements in the yield curve for information about future economic fundamentals. In several recent episodes, however, disruptions to market liquidity have affected the short-term dynamics of the curve independently of fundamentals. This article provides evidence that the short-run dynamics in the intermediate maturities of the yield curve changed around 1990, with the appearance of positive feedback in weekly interest rate changes. The feedback is consistent with the effects of options dealers? hedging activity and it is found only in the ...
Time-varying consumption correlation and the dynamics of the equity premium: evidence from the G-7 countries
We examine the implications of time variation in the correlation between the equity premium and nondurable consumption growth for equity return dynamics in G-7 countries. Using a VAR-GARCH (1,1) model, we find that the correlation increases with recession indicators such as above-average unemployment growth and with proxies for stock market wealth. The combined effect is that the correlation increases during a recession. We find that the effect of a countercyclical correlation is that the equity premium, Sharpe ratio, and risk aversion are also generally countercyclical. These findings ...
Bond market in turmoil
Log-periodogram estimation of long memory volatility dependencies with conditionally heavy tailed returns
Many recent papers have used semiparametric methods, especially the log-periodogram regression, to detect and estimate long memory in the volatility of asset returns. In these papers, the volatility is proxied by measures such as squared, log-squared and absolute returns. While the evidence for the existence of long memory is strong using any of these measures, the actual long memory parameter estimates can be sensitive to which measure is used. In Monte-Carlo simulations, I find that the choice of volatility measure makes little difference to the log-periodogram regression estimator if the ...