My research also documents empirical patterns that hint at alternative ways of modeling expectations in macroeconomics.
I use the term structure model in Cochrane and Piazzesi (2008) and construct currency market prices. The implied currency market prices are counterfactually volatile and predictable, at least with respect to commonly used predictor variables. Getting the model closer to currency market data means reducing bond risk compensation but doing so nearly eliminates predictability in bond markets. One way to generate sensible time-variation in predictable bond and currency excess returns allows the volatility of returns to be time-varying. Additional avenues that can jointly account for the stochastic properties of bond and currency excess returns are also discussed.
JEL Classification: E43, E47, F31, F37, G12, G15
Keywords: forward premium anomaly; return predictability; term structure models; time-varying volatility
I construct alternative forecast rules in relation to the return forecasting factor of Cochrane and Piazzesi (2005,2008) to determine their relative performance. I compare forecasts assuming all historical data is available to recursively made ones that are revised with the arrival of news. Differences in the two forecast rules systematically move with realized bond excess returns. This anticipation effect also forecasts future short-rates and interest rate levels in government bond markets of other industrialized economies. I show that lower long-term rates relative to short-rates in 2004-2005 is consistent with an expected decline of interest rates by market participants. Finally, I discuss macroeconomic factors in relation to my analysis.
I analyze foreign exchange market data in relation to the literature using results from Mang (2012, 2014). For industrialized currencies, the spread in the return forecasting factor of Cochrane and Piazzesi (2005, 2008) and Mang (2014) forecasts currency excess returns and exchange rate changes. Return forecasting factor spreads can be viewed as a systematic reaction to expected future changes in interest rate differentials; market participants are anticipating and reacting to the uncertainty of the duration of these spreads. This proposed explanation not only resolves the departure from uncovered interest parity once these systematic factors are ex-post identified and accounted for at short-term frequencies, exchange rate fluctuations are consistent with its predictions at longer horizons.
JEL Classification: C2, D83, D84, E32, E37, E44, F31, F44, G14
Keywords: adaptive learning; expectations formation; forward premium anomaly; foreign exchange markets; return predictability
I construct an investment portfolio by aggregating value strategies across asset classes. An asset class diversified portfolio of value investments achieves a desirable risk-return profile. The large risk-adjusted returns result from aggregating imperfectly correlated value strategies whose risk-premium survives asset class diversification. To understand the global nature of excess returns to these value investments, I employ a univariate statistic that aggregates signals from individual global value strategies. I find statistical evidence of cross-sectional and time-series predictability only for value-based strategies and not market-capitalization based ones.