Asset Prices and the Macroeconomy

Paper Session

Friday, Jan. 6, 2017 10:15 AM – 12:15 PM

Hyatt Regency Chicago, Crystal A
Hosted By: American Economic Association
  • Chair: Athanasios Orphanides, Massachusetts Institute of Technology

Monetary Policy and the Stock Market: Time-Series Evidence

Michael Weber
,
University of Chicago
Andreas Neuhierl
,
University of Notre Dame

Abstract

We construct a slope factor from changes in federal funds futures of different horizons. The slope factor predicts stock returns at the weekly frequency: faster monetary policy easing positively predicts excess returns. The predictability is robust to the inclusion of standard return predictors and holds across subsamples and out of sample. The predictability we uncover is economically significant. Investors can achieve increases in weekly Sharpe ratios of 20% conditioning on the slope factor when forming portfolios. Federal Open Market Committee (FOMC) meetings do not drive our findings, but speeches by the FOMC chair and vice chair change the slope factor. The slope factor contains information about the speed of future monetary policy tightening and loosening and predicts changes in future interest rates beyond the next FOMC meeting. Macro news explains 9% of the variation in the slope factor, but cannot explain the return predictability. Our findings show that monetary policy affects asset prices throughout the year and not only at FOMC meetings.

Stock Price Booms and Expected Capital Gains

Klaus Adam
,
University of Mannheim
Albert Marcet
,
University of Barcelona
Johannes Beutel
,
University of Mannheim

Abstract

The booms and busts in U.S. stock prices over the post-war period can to a large extent be explained by ‡fluctuations in investors’ subjective capital gains expectations. Survey measures of these expectations display excessive optimism at market peaks and excessive pessimism at market troughs. Formally incorporating subjective price beliefs into an otherwise standard asset pricing model with utility maximizing investors, we show how subjective belief dynamics can temporarily delink stock prices from their fundamental value and give rise to asset price booms that ultimately result in a price bust. The model quantitatively replicates (1) the volatility of stock prices and (2) the positive correlation between the price dividend ratio and expected returns observed in survey data. We show that models imposing objective or ‘rational ’price expectations cannot simultaneously account for both facts. Our …findings imply that large parts of U.S. stock price ‡fluctuations are not due to standard fundamental forces, instead result from self-reinforcing belief dynamics triggered by these fundamentals.

Credit-Market Sentiment and the Business Cycle

David Lopez-Salido
,
Federal Reserve Board
Jeremy Stein
,
Harvard University
Egon Zakrajsek
,
Federal Reserve Board

Abstract

Using U.S. data from 1929 to 2013, we show that elevated credit-market sentiment in year t – 2 is associated with a decline in economic activity in years t and t + 1. Underlying this result is the existence of predictable mean reversion in credit-market conditions. That is, when our sentiment proxies indicate that credit risk is aggressively priced, this tends to be followed by a subsequent widening of credit spreads, and the timing of this widening is, in turn, closely tied to the onset of a contraction in economic activity. Exploring the mechanism, we find that buoyant credit-market sentiment in year t – 2 also forecasts a change in the composition of external finance: net debt issuance falls in year t, while net equity issuance increases, patterns consistent with the reversal in credit-market conditions leading to an inward shift in credit supply. Unlike much of the current literature on the role of financial frictions in macroeconomics, this paper suggests that time-variation in expected returns to credit market investors can be an important driver of economic fluctuations.

Relative Excess Bond Premium, Economic Activity and Fragmentation

Roberto De Santis
,
European Central Bank

Abstract

Using either yield-to-maturity spreads or asset swap spreads for 2345 Eurobonds across euro area non-fi…nancial industries, we estimate a market-wide relative excess bond premium - a proxy for market sentiment -, which can predict real economic activity, the stock market and survey-based economic sentiment. This premium was highly negative between March 2003 and June 2007 in all bond segments and turned positive since then up to the launch of the 3-years long term re…finincing operations in December 2011, predicting the …financial crisis and the two recessions. Finally, using the countries’ excess bond premia, we …find that fragmentation risk increased sharply after Lehman’s bankruptcy and during the sovereign debt crisis.
Discussant(s)
Frank Smets
,
European Central Bank
Michele Boldrin
,
Washington University-St. Louis
Francesco Bianchi
,
Duke University
Stefania D'Amico
,
Federal Reserve Bank of Chicago
JEL Classifications
  • E4 - Money and Interest Rates
  • G1 - Asset Markets and Pricing