Business Cycle Patterns Research Articles

Why are aggregate equity payouts pro-cyclical?

We use two general equilibrium models to explain why changes in the external economic environment result in pro-cyclical aggregate dividend payout behavior. Both models that we consider endogenize low elasticity of investment. The first model incorporates capital adjustment costs, while the second one assumes that risk-averse managers maximize their own objective function rather than shareholder wealth. We show that, while both models generate pro-cyclical aggregate dividends, a feature consistent with the observed business-cycle pattern of payouts from well-diversified portfolios, the second model provides a more likely explanation for this effect. Our findings emphasize the importance of incorporating agency conflicts when considering the relationship between the external economic environment and the financial behavior of businesses.

Unemployment and Labor Reallocation in Europe

We ask whether sectoral shocks and the subsequent labor reallocation are responsible for unemployment within selected European economies. Our measure of sectoral labor reallocation is adjusted for aggregate influences and the remaining variation is linked to unemployment in country specific dynamic models. For Spain, the ADL-model estimation reveals a significant impact of sectoral reallocation on unemployment that goes beyond usual business cycle patterns. In Italy, there is weaker yet detectable evidence for this mechanism. In Ireland, Portugal and France, no significant influence of sector level shocks on unemployment is found. The results emphasize the potential structural supply side policies have for reducing unemployment in Spain.

Forecasting GDP growth using mixed-frequency models with switching regimes

For modelling mixed-frequency data with a business cycle pattern, we introduce the Markov-switching Mixed Data Sampling model with unrestricted lag polynomial (MS-U-MIDAS). Usually, models of the MIDAS-class use lag polynomials of a specific function which impose some structure on the weights of the regressors included in the model. This may lead to a deterioration in the predictive power of the model if the structure imposed differs from the data generating process. When the difference between the available data frequencies is small and there is no risk of parameter proliferation, using an unrestricted lag polynomial might not only simplify the model estimation, but also improve its forecasting performance. We allow the parameters of the MIDAS model with an unrestricted lag polynomial to change according to a Markov-switching scheme in order to account for the business cycle pattern observed in many macroeconomic variables. Thus, we combine the unrestricted MIDAS with a Markov-switching approach and propose a new Markov-switching MIDAS model with unrestricted lag polynomial (MS-U-MIDAS). We apply this model to a large dataset with the help of factor analysis. Monte Carlo experiments and an empirical forecasting comparison carried out for the U.S. GDP growth show that the models of the MS-U-MIDAS class exhibit nowcasting and forecasting performances which are similar to or better than those of their counterparts with restricted lag polynomials.

Business cycle, storage, and energy prices

This study examines the effect of the state of the economy and inventory on interest-adjusted bases and expected returns for five energy commodities. We find that interest-adjusted bases and returns have a business cycle pattern. Consistent with the theory of storage, demand shocks near business cycle peaks generate negative interest-adjusted bases and positive returns. In recessions, the bases become positive, and the average returns are negative. Our regression results also show that the interest-adjusted bases of energy commodities are counter-cyclical and the expected returns are pro-cyclical. For petroleum commodities, inventory has a significant effect on interest-adjusted bases at low levels of inventory, whereas at high inventory levels the effect of inventory on the bases is weak. Finally, we find that the bases and economic conditions predict spot returns in energy commodity markets.

The Investors' Belief in Stock Returns and Volatilities

Motivated by the asset pricing implications of the regime-switching equilibrium models in the literature, this paper investigates empirically the effects of regime switches in aggregate stock returns and volatilities. The investors' belief, defined as the posterior probability of the bear regime, is estimated based on a regime-switching model where the regime of the economy follows a two-state hidden Markov process. Veronesi (1999) shows that both the expected excess return and the volatility of the returns are the concave, bell-shaped functions of the investors' belief if risk aversion is a constant.The empirical findings in this paper suggest that the expected excess return and the volatility are monotonically increasing functions of the investors' belief. Therefore, a reasonable explanation for the empirical finding is that risk aversion is time-varying and the representative agent is more risk averse in the bear regime so that a higher expected excess return and higher volatility in the bad regime are generated. A second empirical finding is that the stock return predictors, such as the term spread, the in flation rate, and the T-bill rate, have significant business cycle patterns in the predictive regressions. For example, the term spread is positively related to the stock market returns in the boom regime, but is negatively related to the stock market returns in the bear regime. This suggests that the increasing term spread is good news in the bear regime because it indicates that the economy is improving and will recover soon, thus the investors require a lower equity premium. In addition, the equity premium is more sensitive to the predictors in the bear regime because the bear regime is short lived. Similar results are also found in the predictive regressions for the variance of the stock market returns.

Rising BRICs and Changes in Sub-Saharan Africa’s Business Cycle Patterns

This paper assesses the extent to which Sub-Saharan Africa (SSA)’s business cycle is synchronized with that of the rest of the world (RoW). Findings suggest that SSA’s business cycle has not only moved in the same direction as that of the RoW, but has also gradually drifted away from the G7 in favour of the BRICs. Trade with the BRICs turns out to be the strongest driver of this shift. Much of this impact unfolds through aggregate demand impulse from trade. As fiscal policy stances in SSA and the BRICs are not synchronized, they have not caused cyclical output correlation between these two groups of countries. Also, financial openness, which is at a very early stage across most SSA countries, has acted as a neutral force.

Rising BRICs and Changes in Sub-Saharan Africa's Business Cycle Patterns

This paper assesses the extent to which Sub-Saharan Africa (SSA)’s business cycle is synchronized with that of the rest of the world (RoW). Findings suggest that SSA’s business cycle has not only moved in the same direction as that of the RoW, but has also gradually drifted away from the G7 in favour of the BRICs. Trade with the BRICs turns out to be the strongest driver of this shift. Much of this impact unfolds through aggregate demand impulse from trade. As fiscal policy stances in SSA and the BRICs are not synchronized, they have not caused cyclical output correlation between these two groups of countries. Also, financial openness, which is at a very early stage across most SSA countries, has acted as a neutral force.

Financing Asset Sales and Business Cycles

Using a dynamic model of financing, investment, and macroeconomic risk, we investigate when firms sell assets to fund investments (financing asset sales) across the business cycle. The model reveals that financing asset sales entail a lower wealth transfer from equity to debt than otherwise identical but equity financed investments. Exploring the dynamics of this motive across business cycles helps explain novel stylized facts about asset sales and their business cycle patterns that cannot be rationalized by traditional motives for selling assets.

Business Cycle Implication of Long-Run Risk Consumption CAPM: Korean Stock Market Evidence

This paper examines long-run consumption based asset pricing models by studying sixteen Fama-French size and book-to-market portfolios in KRX (Korea Exchange) as test assets. In our empirical implementation, we follow both models of Hansen, Heaton and Li (2008) and Parker and Julliard (2005). Hansen, Heaton and Li (2008) used recursive utility framework. The stochastic discount factor for this model depends on the present value of expectations about future consumption growth rates. In the empirical specification for this model, we follow Malloy, Moskowiz and Vissing-Jørgensen (2008). Meanwhile, Parker and Julliard (2005) proposed a model based upon the power utility framework and explicitly considers the consumption adjustment period. Our main results are surprisingly consistent with the results of existing literatures. By assessing both of these models, we find that the significance of the excess returns of the test assets in predicting consumption growth peaks at the horizon of 2.5 years. These empirical results partly proves the existence of long-run consumption risk in Korean economy. We can relate stock returns to long-run consumption risk and business cycle. Specifically, the stochastic discount factor of Parker and Julliard’s model captures the financial crises in the years of 1997 and 2003. Moreover, it catches the business cycle pattern of composite leading index in Korea.

CONSUMPTION–LEISURE TRADE‐OFFS AND PERSISTENCY IN BUSINESS CYCLES

ABSTRACTThis paper studies whether non‐separabilities between consumption and leisure may help to explain the observed persistence in GNP growth. We consider an extended version of Lucas's (1988) human capital investment model that includes labour adjustment costs and compare its performance under different utility specifications with different degrees of complementarity and substitutability between consumption and leisure. We find that when consumption and leisure are complements the model succeeds in matching not only the autocorrelation of output growth but also the important trend‐reverting component found in US data. These results hold even if low adjustment costs of labour are considered. Hence, we conclude that an arguably simple margin not considered conventionally can provide useful insights into observed business cycle patterns.

Economic intermittency in a two-country model of business cycles coupled by investment

Intermittent behavior of economic dynamics is investigated by a two-country model of Keynes–Goodwin type business cycles. Numerical simulations show that after an economic system evolves from weak chaos to strong chaos the system keeps its memory before the transition and its time series alternates episodically between periods of weakly and strongly chaotic fluctuations. In addition, we examine the intermittent phenomena from the view point of business cycle patterns near the crisis point.

What is the Consumption-CAPM Missing? An Information-Theoretic Framework for the Analysis of Asset Pricing Models

We study a broad class of asset pricing models in which the stochastic discount factor (SDF) can be factorized into an observable component (e.g., a parametric function of consumption) and a potentially unobservable one (e.g., habit level or the return on total wealth). Exploiting this decomposition we derive new entropy bounds that restrict the admissible regions for the SDF and its components. Without using this decomposition, we show that, to a second order approximation, entropy bounds are equivalent to the canonical Hansen-Jagannathan bounds. However, bounds based on our decomposition have higher information content, are generally tighter, and naturally exploit the restriction that the SDF is a positive random variable. In addition, our information-theoretic framework enables us to extract a non-parametric estimate of the unobservable component of the SDF. Empirically we find that this component, in addition to following a clear business cycle pattern, has significant correlation with financial market crashes unrelated to economy-wide contractions. We apply our methodology to the leading consumption-based asset pricing models, gaining new insights about their empirical performance and finding empirical support for the Long Run Risk framework.

International Business Cycles: How Do They Relate to Switzerland?

This paper first discusses concepts, definitions and theoretical explanations for international business cycles. This is followed by an overview of previous empirical studies. We then argue that for ex post analyses the output gap is a univariate quantification of the business cycle that is comparable across space and time and readily available (or rather computable from GFP series), which recommends its use for our purposes. Based on an unbalanced panel of quarterly output gap series in a panel of 40 countries from 1960q1 to 2011q3, we then test a number of hypotheses regarding the imbeddedness of the Swiss economy into international business cycles and possible changes thereof over the recent years. The results identify layers of international business cycles, where the integration of Switzerland is pronounced. Moreover it markedly deepened after 1994. A case for Switzerland being ‘special’ can hence not be made in terms of its recent business cycle pattern.

Modeling news-driven international business cycles

This paper reexamines the question of how to explain business cycle co-movements within and between countries. First, we present a simple flexible price models to illustrate how and why news shocks can generate robust positive co-movements in economic activity across countries. We also discuss under what conditions a two-sector version of the model generates appropriate business cycle patterns within countries. Second, we develop a quantitative two-country two-sector model that is capable of replicating news driven international business cycles. The model is a two-country extension of the closed economy model of Beaudry and Portier (2004), in which there are limited possibilities to reallocate factors between investment and consumption-good sectors.

Endogenous OCA Analysis and the Early Euro Experience

Some have argued that the endogenous responses to the formation of a currency area are so strong that one need not worry about optimum currency area conditions ex ante. We argue that this is much too strong a conclusion. We draw on a number of recent studies to evaluate the endogeneity experiences of the eurozone in three major areas; trade flows, business cycle synchronisation and structural reforms to improve labour and product market flexibility. Simple before-and-after comparisons are insufficient for analysis of endogeneity. The experiences of non-euro Western European economies suggest that broader trends also had considerable influence on trade and business cycle patterns. While trade rose substantially within the eurozone, it also rose with and among other European economies. We argue that political economy considerations tend to dampen the magnitude of endogeneity efforts on structural reforms and that meeting conditions for entry may be a more powerful mechanism in this than are subsequent endogenous responses. We also discuss a number of areas for further research.

National and International Business Cycle Effects of Housing Crises

Housing crises usually go hand in hand with a long lasting recession and a considerable loss in output. We first re-examine the effects of a housing crises on the business cycle based on historical crises. Then we estimate the international spill-over-effects if several huge industrial countries face a housing crisis simultaneously. While the economic impact of the housing crisis in the United States, from a historical perspective, should have bottomed out at the end of 2008 and the business cycle pattern differed significantly from that in a typical crisis, house prices in Great Britain, Spain and France just started to drop at the end of 2007. If we assume that a typical housing crisis occurs in all of these three countries, international transmission effects then would lead to significant losses of GDP growth in several other countries, notably in Europe.

Riding the Waves of Investment Returns

It is common knowledge that economic activity follows cyclical processes of different length like the business cycle or seasonal patterns throughout a calendar year. These cyclical patterns are usually distorted by noise and singular events that influence financial markets over the short term. This paper shows how one can filter out the cyclical patterns of investment returns and use this information in order to create superior active investment returns. It is shown that the filtered data will be a good indication of return trends for the asset class considered. In the long run (that is an investment horizon of more than four years) the short term noise should be of negligible importance for the investment performance. This implies that a portfolio that dynamically allocates the portfolio weights according to the expected future filtered returns should be able to add value for long term investors. Here, a simple dynamic portfolio asset allocation process is developed based on the future returns as calculated from the filtered data. The performance of this model portfolio is compared to a passive benchmark portfolio with fixed portfolio weights and maximum Sharpe ratio for the sampling period as well as to an active portfolio that allocates the portfolio weights with a simple momentum approach. The results of our in sample as well as our out of the sample tests show that the model portfolio that relies only on medium to long term cyclical economic activity does outperform both the passive benchmark and the actively managed momentum portfolio in terms of absolute return and in terms of risk adjusted returns (Sharpe ratio). The outperformance is high enough (generally between 1.5% and 5% per annum) to persist even when transaction costs are considered in the model. Also, the Information Ratios of the Model Portfolios are generally in the region between 0.4 and 0.7 for the out of sample data which is an excellent value for a purely quantitative approach. Finally, the superior performance appears to be stable over investment horizons of more than four years.

Financial Integration and Business Cycle Synchronization

Standard theory predicts that financial integration leads to a lower degree of business cycle synchronization. Surprisingly, cross-country studies find the opposite. Our contribution is to document the theoretically predicted negative effect of financial integration on business cycle synchronization as a robust regularity. We use a confidential dataset on banks' international bilateral exposure over the past three decades in a panel of twenty developed countries. The rich panel structure allows us to control for time-invariant country-pair factors and global trends that affect both financial integration and business cycle patterns. In contrast to previous empirical work we find that a higher degree of financial integration is associated with less synchronized output cycles. We also employ two distinct instrumental variable approaches to identify the one-way effect of integration on synchronization. These specifications reveal that the component of banking integration predicted by legislative-regulatory harmonization policies and the nature of the bilateral exchange rate regime has a negative effect on output synchronization.

Regional Patterns of Venture Capital Financing in the US

This paper analyses the development of venture capital financing in the US covering a time period from the beginning of 1995 until 2008 (third quarter). Its focus is the structural changes emerging from reallocation of financial resources over time with special emphasis on regional allocation based on quarterly data collected by the National Venture Capital Association (NVCA) and Price WaterhouseCoopers as the MoneyTree dataset. Taking into account the multiple dimensions offered by stages of venture financing cycle, direction of industries, and regional allocation together with the overall business cycle patterns one key finding is a fairly steady concentration process of US venture capital financing in two key destinations as the Silicon Valley and New England. This trend even prevails with a significant shift from ICT related research industry areas towards biotechnology, health and energy over the respective time period. Furthermore after the burst of the new economy bubble in particular start-up/seed early stage financing lost in importance measured by their respective shares in favour of financing for expansion and later stage financing. This indicates an increasing risk averseness in venture capital financing which might be attributed to the high degree of uncertainty of early stages.

Measurement Error in Monetary Aggregates: A Markov Switching Factor Approach

This paper compares the different dynamics of the simple sum monetary aggregates and the Divisia monetary aggregate indexes over time, over the business cycle, and across high and low inflation and interest rate phases. Although traditional comparisons of the series sometimes suggest that simple sum and Divisia monetary aggregates share similar dynamics, there are important differences during certain periods, such as around turning points. These differences cannot be evaluated by their average behavior. We use a factor model with regime switching. The model separates out the common movements underlying the monetary aggregate indexes, summarized in the dynamic factor, from individual variations in each individual series, captured by the idiosyncratic terms. The idiosyncratic terms and the errors reveal where the monetary indexes differ. We find several new results. In general, the idiosyncratic terms for both the simple sum aggregates and the Divisia indexes display a business cycle pattern, especially since 1980. They generally rise around the end of high interest rate phases - a couple of quarters before the beginning of recessions - and fall during recessions to subsequently converge to their average in the beginning of expansions. We find that the major differences between the simple sum aggregates and Divisia indexes occur around the beginnings and ends of economic recessions, and during some high interest rate phases. We note the policy relevance of the inferences. Indeed, as Belongia (1996) has observed in this regard, measurement matters.