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« Back to Results

Asset Return Dynamics

Paper Session

Friday, Jan. 5, 2018 8:00 AM - 10:00 AM

Loews Philadelphia, Commonwealth Hall B
Hosted By: American Finance Association
  • Chair: Dana Kiku, University of Illinois

Level and Volatility Shocks to Fiscal Policy: Term Structure Implications

Alex Hsu
,
Georgia Institute of Technology
Andrea Tamoni
,
London School of Economics
Lorenzo Bretscher
,
London School of Economics

Abstract

We study the impact of fiscal policy shocks on bond risk premia. Government spending level shocks generate positive covariance between marginal utility and inflation (term structure level effect) making nominal bonds a poor hedge against consumption risk leading to positive inflation risk premia. Volatility shocks to spending have strong slope effect (steepening) on the yield curve, producing positive nominal term premia. For level and volatility shocks to capital income tax, term structure level effects dominate, delivering negative risk premia. Fluctuations in term premia are entirely driven by volatility shocks. Lastly, fiscal shocks are amplified at the zero lower bound.

Habits and Leverage

Tano Santos
,
Columbia University
Pietro Veronesi
,
University of Chicago

Abstract

Many stylized facts of leverage, trading, and asset prices follow from a frictionless general equilibrium model that features agents’ heterogeneity in endowments and habit preferences. Our model predicts that aggregate debt increases in good times when stock
prices are high, return volatility is low, and levered agents enjoy a “consumption boom.” Our model is consistent with poorer agents borrowing more and with recent evidence on intermediaries’ leverage being a priced factor of asset returns. In crisis times, levered agents strongly deleverage by “fire selling” their risky assets as asset prices drop. Yet,
consistently with the data, their debt-to-wealth ratios increase because their wealth decline faster due to higher discount rates.

Fearing the Fed: How Wall Street Reads Main Street

Tzuo Hann Law
,
Boston College
Dongho Song
,
Boston College
Amir Yaron
,
University of Pennsylvania

Abstract

We provide strong evidence of persistent cyclical variation in the sensitivity of stock prices to macroeconomic news announcement (MNA) surprises. The stock market sensitivity is muted during the early recession and the late expansion phases of the economy, however, it increases significantly, reaching peak values in the early expansion phase. We show that market expectations and uncertainty about the future interest rate path is one of the primary drivers of the cyclical market response to MNAs -- responses depend on whether the Fed is expected to be reactive. Evidence from survey forecasts and a monetary regime-switching model corroborates the connection between the cyclical stock responses and monetary policy expectations. A decomposition of the stock market responses shows that they primarily reflect news about cash flows and interest rate rather than risk premia news.
Discussant(s)
Erica Li
,
Cheung Kong Graduate School of Business
Leonid Kogan
,
Massachusetts Institute of Technology
Jonathan Wright
,
Johns Hopkins University
JEL Classifications
  • G1 - General Financial Markets