Asset Prices and the Macroeconomy
Friday, Jan. 6, 2017 10:15 AM – 12:15 PM
Hyatt Regency Chicago, Crystal A
- Chair: Athanasios Orphanides, Massachusetts Institute of Technology
Stock Price Booms and Expected Capital Gains
AbstractThe 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
AbstractUsing 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
AbstractUsing 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 Lehmans bankruptcy and during the sovereign debt crisis.
European Central Bank
Washington University-St. Louis
Federal Reserve Bank of Chicago
- E4 - Money and Interest Rates
- G1 - Asset Markets and Pricing