Macro Expectations, Aggregate Uncertainty, and Expected Term Premia

Dick, Christian D.; Schmeling, Maik; Schrimpf, Andreas

doi:10.2139/ssrn.1668576

Cited by 15 publications

(17 citation statements)

References 45 publications

Supporting

Mentioning

Contrasting

Order By: Relevance

“…As mentioned in the Introduction, such an approach complements a large literature relying on survey information for forecasting and understanding bond market dynamics. Although studies such as Chun (2011), Wright (2011), Chernov and Mueller (2012), Dick et al (2013), Piazzesi et al (2015), and Joslin et al (2014) rely on survey forecasts to understand yield dynamics and improve term premia estimates, I follow the tradition of, among others, Cochrane and Piazzesi (2005) and Ludvigson and Ng (2009) and study the predictive ability of survey forecasts for bond risk premia directly in a predictive regression framework. 6 The use of survey forecasts in such a setting, where the aim is to investigate the link between expected business conditions and bond risk premia, seems ideal for several reasons.…”

Section: Measuring Expected Business Conditionsmentioning

confidence: 99%

“…A related result is established in Altavilla, Giacomini, and Constantini (2014) whose monetary policy expectations, however, are extracted from federal funds rate futures. Dick, Schmeling, and Schrimpf (2013) use forecasters' subjective yield expectations to construct a real-time proxy for expected term premia that predicts future bond risk premia. A similar approach is found in Piazzesi, Salomao, and Schneider (2015).…”

Section: Introductionmentioning

confidence: 99%

See 1 more Smart Citation

Expected Business Conditions and Bond Risk Premia

Eriksen¹

2017

J. Financ. Quant. Anal.

View full text Add to dashboard Cite

This paper studies the predictability of bond risk premia by means of expectations to future business conditions using survey forecasts from the Survey of Professional Forecasters. We show that expected business conditions consistently affect excess bond returns and that the inclusion of expected business conditions in standard predictive regressions improve forecast performance relative to models using information derived from the current term structure or macroeconomic variables. The results are confirmed in a real-time out-of-sample exercise, where the predictive accuracy of the models is evaluated both statistically and from the perspective of a mean-variance investor that trades in the bond market.Keywords: Bond risk premia, expected business conditions, predictability, economic value, expectations hypothesis, time-varying risk premia JEL Classification: E43, E44, E47, G11, G12. IntroductionThere is mounting evidence that the risk premia required by investors for holding Treasury bonds contain a time-varying and predictable component. One strand of research relates such variations to forward spreads (Fama and Bliss, 1987;Fama, 2006), yield spreads (Keim and Stambaugh, 1986;Campbell and Shiller, 1991), and forward rates (Cochrane and Piazzesi, 2005;Dahlquist and Hasseltoft, 2013;Zhu, 2015), whereas more recent studies link the predictable component to factors whose variations lie outside the span of current yields. Existing research within this strand has uncovered a wide array of factors including jump risk (Wright and Zhou, 2009), option prices (Almeida, Graveline, and Joslin, 2011), and macroeconomic variables (Ilmanen, 1995;Moench, 2008;Cooper and Priestley, 2009;Ludvigson and Ng, 2009;Wright, 2011;Favero, Niu, and Sala, 2012;Joslin, Priebsch, and Singleton, 2014;Zhou and Zhu, 2015).While existing studies mainly rely on information in the current term structure and business environment to explain variations in the predictable component of bond risk premia, our study takes a forward-looking perspective by studying the link between expected business conditions and bond risk premia using survey forecasts from the Survey of Professional Forecasters (SPF). Albeit empirical studies frequently conclude that macroeconomic fundamentals carry information about bond risk premia not already captured by the yield curve, they rarely account for issues with publication lags and data revisions in macroeconomic time series. As recently demonstrated by Ghysels, Horan, and Moench (2014), such features may drive a wedge between the factor spaces spanned by latent common factors extracted from a panel of revised and non-revised data, respectively, implying that a sizable fraction of the predictability documented by Ludvigson and Ng (2009) may largely be driven by revision and publication lag components that are unavailable to an investor in real-time. Survey forecasts, as a result, provide an ideal data source for studying the predictability of bond risk premia as they are model-free, available in real-time, and not...

show abstract

Section: Measuring Expected Business Conditionsmentioning

confidence: 99%

Section: Introductionmentioning

confidence: 99%

Expected Business Conditions and Bond Risk Premia

Eriksen¹

2017

J. Financ. Quant. Anal.

View full text Add to dashboard Cite

show abstract

“…They model uncertainty as a mean‐preserving spread in the distribution of money growth. Buraschi and Jiltsov (), Arnold and Vrugt (), Dick, Schmeling, and Schrimpf (), Buraschi, Carnelli, and Whelan (), and D'Amico and Orphanides () find that uncertainty about monetary policy or the inflation target is a main driver of bond market volatility and the size of the term premium, respectively. The authors use information from surveys of financial professional forecasters to proxy uncertainty.…”

mentioning

confidence: 99%

Monetary Policy Uncertainty and the Response of the Yield Curve to Policy Shocks

Tillmann¹

2019

J of Money Credit Banking

View full text Add to dashboard Cite

This paper studies the nonlinear response of the term structure of interest rates to monetary policy shocks and presents a new stylized fact. We show that uncertainty about monetary policy changes the way the term structure responds to monetary policy. A policy tightening leads to a significantly smaller increase in long-term bond yields if policy uncertainty is high at the time of the shock. We also look at the decomposition of bond yields into expectations about future policy and the term premium. The weaker response of yields is driven by the fall in term premia, which fall more strongly if uncertainty about policy is high. Conditional on a monetary policy shock, higher uncertainty about monetary policy tends to make securities with longer maturities relatively more attractive to investors. As a consequence, investors demand even lower term premia. These findings are robust to the measurement of monetary policy uncertainty, the definition of the monetary policy shock, and to changing the model specification.JEL codes: E43, E58, G12 Keywords: monetary policy uncertainty, term structure, term premium, unconventional monetary policy, local projections.THE TERM STRUCTURE OF INTEREST rates, that is, the range of bond yields across the maturity spectrum, is closely tracked by central bankers and market participants. The reason for this is twofold. First, long-term interest rates should contain information about the public's expectations about future monetary policy. Central banks use the term structure to study the stance of monetary policy perceived by markets. Second, the term structure itself can be a policy target. allow for the effects of conventional and unconventional monetary policy shocks on yields to vary over time.

show abstract

“…Second, since our sample period largely coincides with the extraordinary turmoil periods, movements in both long‐term bond yields and stock returns may be predominantly driven by the same real economic shocks and the worsening global economic outlook. As a matter of fact, expected term premium in bond markets and the state of the economy, particularly uncertainty about real output growth, have a strong link (Dick et al ., ), inducing higher co‐movements as bond yields become more sensitive to the growth prospects (Rankin et al ., ). Third, another potential reason behind the positive linkage is the so‐called ‘flight‐to‐quality’ (FTQ) effect at times of stock market turbulence.…”

Section: Resultsmentioning

confidence: 99%

Stock‐bond Co‐movements and Flight‐to‐quality in G7 Countries: A Time‐frequency Analysis

Bayracı

Demiralay

Gencer

2017

Bulletin of Econ Res

View full text Add to dashboard Cite

This paper examines co-movement between stock returns and changes in 10-year government bond yields as well as flight-to-quality behaviour in G7 countries. We conduct the wavelet squared coherence analysis to explore the dynamics in both time and frequency domain. Our results provide evidence of positive co-movements, which vary over time and across investment horizon. The higher co-movement is found to be more concentrated in the lower frequency bands. We further analyse the dynamic nature of the scale-dependent wavelet correlations and find that the correlations are highly volatile and significantly increase across different time scales during the episodes of equity market turbulence. The increase in correlations reflects flights from stocks to safer bond investments as a result of dramatic changes in investor sentiment and risk aversion at times of market stress. equal to the present value of all projected cash flows discounted at the appropriate discount rate. 1 Interest rates generally affect stock prices via two main channels. First, interest rate changes directly influence the discount rate in standard stock valuation models. Second, variations in interest rates impact cost of financing and hence significantly change expectations about cash flows. In other words, the rising cost of borrowing decreases the expected future cash flow, causing stock price to fall. Therefore, movements in interest rates may have a negative influence on stock prices. In this regard, bond yield variations also affect tactical portfolio allocation strategies which are closely followed for an efficient rebalancing between risk and return in order to impede the catastrophic effects of unanticipated changes in economic expectations.As a result of financial market integration, crises are transmitted from one economy (or asset) to another easily, becoming an epidemic. 2 This situation makes international diversification inefficacious in the presence of contagion at times of economic turmoil. Consequently, financial market participants are forced to avail themselves of different asset classes for diversification benefits. The phenomenon called as 'flight-to-quality' enables investors to redesign their portfolios towards less risky assets at times of distress. More commonly, bonds are viewed as quality assets against stocks. Hartmann et al. (2004) suggest that 'flight-to-quality is about as frequent as simultaneous crashes of stock and bond markets'. One of the most comprehensive definitions of 'flight-to-quality' (FTQ) phenomenon comes from Baur and Lucey (2009). 3 They advocate that the co-movements between stock and bond returns decline during stock market plunges. Investors flee from stocks to bonds in order to compensate the losses incurred in the equity markets at times of adverse stock market conditions. By contrast, they attribute the 'flightfrom-quality' to the decreasing co-movements in bullish market episodes. In this case, investors shift their holdings from bonds to stocks to exploit the potential profits from the rising equ...

show abstract

Macro Expectations, Aggregate Uncertainty, and Expected Term Premia

Cited by 15 publications

References 45 publications

Expected Business Conditions and Bond Risk Premia

Expected Business Conditions and Bond Risk Premia

Monetary Policy Uncertainty and the Response of the Yield Curve to Policy Shocks

Stock‐bond Co‐movements and Flight‐to‐quality in G7 Countries: A Time‐frequency Analysis

Contact Info

Product

Resources

About