Interest Rate Cycle Research Articles

Exploiting non-parallel risk premia in the South African sovereign bond market

Background: This study focuses on diversifying fixed income attribution beyond yield and duration by identifying new risk premia applicable to various investment strategies.Aim: To identify cross-sectional bond risk factors in the South African sovereign bond market, capitalising on non-parallel shifts during high-risk macroeconomic events, developing a strategy to extract persistent alpha from higher order interest rate risks and disproving the strong efficient market hypothesis.Setting: This study finds that during high-risk macro events, non-parallel shifts increase in frequency. Empirical evidence suggests that post the 2008 financial crisis, there have been increased occurrences of risk-on/off events and researchers believe high risk macro events will increase in prominence. As such, most active US fixed income managers have reduced duration risk (from parallel shifts) in favour of alternative risk premia.Method: This study exploits slope and curvature risks, by utilising a butterfly strategy. Ten bond risk factors are back-tested and analysed during interest rate cycles, curve scenarios and risk-off periods from 1998 to 2023.Results: The top-ranked strategies displayed strong and persistent outperformance over the bottom-ranked strategies for most of the bond factors especially during risk-on episodes. The Bond All-Factor Rank demonstrated improved diversification by balancing upside and downside risks. Trade costs are an important factor that requires pragmatic management.Conclusion: Geopolitical risks are increasing in frequency and developing a strategy to exploit non-parallel risk premia is an attractive proposition.Contribution: This study identified new bond risk factors beyond the conventional spread factor to extract non-parallel risk premia.

Stochastic Volatility Models with Skewness Selection.

This paper expands traditional stochastic volatility models by allowing for time-varying skewness without imposing it. While dynamic asymmetry may capture the likely direction of future asset returns, it comes at the risk of leading to overparameterization. Our proposed approach mitigates this concern by leveraging sparsity-inducing priors to automatically select the skewness parameter as dynamic, static or zero in a data-driven framework. We consider two empirical applications. First, in a bond yield application, dynamic skewness captures interest rate cycles of monetary easing and tightening and is partially explained by central banks' mandates. In a currency modeling framework, our model indicates no skewness in the carry factor after accounting for stochastic volatility. This supports the idea of carry crashes resulting from volatility surges instead of dynamic skewness.

The Impact of the Fed's Interest Rate Adjustment Cycle on the Price of WTI Crude Oil Futures

This article is based on monthly data from January 2016 to January 2022, including the US Federal Funds Rate and WTI crude oil futures price index. A TVP-VAR model is constructed to study the impact of the Federal Reserve's interest rate cycles on WTI crude oil futures prices. The research found a positive correlation between crude oil futures prices and the Federal Reserve's interest rate cycles. That means that when the Federal Reserve raises or lowers the US Federal Funds Rate, it leads to an increase or decrease in crude oil futures prices. Therefore, it is believed that in the current context of global quantitative easing and the sustained rise in international crude oil prices, China should formulate a new energy strategy that matches the high-quality development of the social economy and accelerate the transformation and upgrading of the crude oil industry.

How do funding diversity and non-performing loans affect bank performance in different economic cycles?

This paper aims to study the impacts of bank funding diversity, non-performing loans (NPLs), and business cycles on bank performance. We employ Fixed Effect Models and the two-step system Generalized Method of Moments to examine a sample of 37 Vietnamese banks from 2005 to 2020. Our findings report that a one percentage point increase in the funding diversity index empowers ROA by 0.031 percentage points. Our results indicate that one positive standard deviation of real GDP from the trend calculated by the Hodrick-Prescott filter increases the ROA by 0.004 percentage points. However, a percentage point increase in non-performing loans reduces ROA by 0.075 percentage points. Our findings are also robust in various proxies of bank performance, economic cycles, and FED interest rate cycles. The findings help determine the optimal funding strategy for policymakers and bank managers. These findings suggest that bank managers develop long-term credit policies to control NPLs, improving sustainable performance. Regulators closely monitor macroeconomic factors to maintain banking stability in different economic stages. Our findings align with the diversification theory, trade-off theory, and prior literature.

Financial cycles across G7 economies: A view from wavelet analysis

We analyse the cross-country dimension of financial cycles by examining cyclical co-movements in credit, house prices, equity prices and interest rates across the G7 economies. We use wavelet-based statistics to assess at which frequencies cyclical fluctuations and their cross-country co-movements are important and how these change over time. We show that cycles in interest rates and equity prices are at least as synchronised as cycles in real GDP, while cycles in credit and house prices are less synchronised. Furthermore, we propose a measure of the importance of common cycles for developments in individual countries. It shows that common cycles across countries in equity prices and long-term interest rates account for a larger share of the volatility of these variables at the country level than is the case for common cycles in credit aggregates. The importance of common cycles for fluctuations at the country level is roughly similar for house price growth and long-term interest rates.

Financial Cycles in Euro Area Economies: A Cross‐Country Perspective Using Wavelet Analysis*

AbstractWe study the cross‐country dimension of financial cycles for six euro area countries using wavelet analysis. Estimated wavelet cohesions show that cycles in equity prices and interest rates display stronger synchronization across countries than real output cycles, whereas credit variables and house prices show lower cross‐country synchronization. We propose a wavelet‐based extension to the spectral envelope that is similar to a frequency‐based time‐varying principal component analysis. The country loadings show that, contrary to all other variables, cycles in loans to households and house prices in Germany and the Netherlands are negatively or less strongly correlated with the common cycles.

State dependence of monetary policy across business, credit and interest rate cycles

We study how phases of the business, credit and interest rate cycles affect the transmission of monetary policy using state-dependent local projection methods and data from 18 advanced economies. We find that the impact of monetary policy shocks on output and other macroeconomic and financial variables is weaker during periods of economic downturns, low household debt, and high interest rates. The business cycle state dependence tends to dominate the other documented state dependencies. We build a small-scale theoretical model to rationalize these facts. The model points to the presence of collateral and debt-service constraints on household borrowing and refinancing as potential drivers of state dependence of monetary policy with respect to the business, credit, and interest rate cycles. Our findings bear significant implications for the transmission of monetary policy, and highlight potentially important features to be considered in models used to inform monetary policy decisions.

Demand elasticity for deposit services at U.S. retail banks in high and low rate environments

ABSTRACT Using techniques from industrial organization, we capture the sensitivity of deposit balances to own and competitor pricing by estimating demand functions in U.S. retail deposit markets. The demand functions are used to compute elasticities of demand for bank deposits in order to study the relative importance of deposit rates over different interest rate environments. We find that the magnitudes of own- and cross-price elasticities are higher in high rate periods (when the federal funds rate is above 2%) than in low rate periods. We also compare different sized firms and find that smaller firms’ elasticities are more sensitive to the interest rate cycle.

Time-Varying Housing Market Fluctuations: Evidence from the U.S. Housing Market

AbstractThe objective of this paper is to investigate how the housing market and credit market factors contribute to US business and interest rate cycles in a time-varying transition probability modeling framework. The Markov switching results appear to exhibit periods of low-growth regime and highgrowth regime for both house and credit markets. The study also shows that the transition probabilities reflecting the regime switching behavior of business and interest rate cycles vary over time as functions of the house and credit market. We find that both the housing market and credit market contribute to whether the economy remains in a high-growth regime or moves into lowgrowth regime, and whether the interest rates remain in a low or high-growth regime. The results show that the housing market plays a leading role in affecting the time-varying probabilities between regimes for the business and interest rate cycles.

The comovement and causality between stock market cycle and business cycle in China: Evidence from a wavelet analysis

This study aims to explore the comovement and causal relationship between the stock market cycle and business cycle in China over the period from 1992Q1 to 2018Q1. While the existing literature treats the relationship as being time- and/or frequency-invariant, we attempt to detect possible time- and frequency-varying patterns by using wavelet analysis. The results show that the stock market cycle tends to lead the business cycle in expansion periods whereas the business cycle tends to lead the stock market in recession periods. Moreover, when the stock market cycle leads the business cycle, they are always positively correlated. In contrast, when the business cycle leads the stock market cycle, they tend to be negatively correlated. In addition, we find that there are substantial time- and frequency-variations in the comovement and causal relationship between the two cycles in China, suggesting the presence of the time- and frequency-variation features should not be ignored in future research. Finally, the relationship can be significantly affected by the domestic interest rates as well as the effect of some external shocks, such as the interest rate and business cycle shocks originated from other major advanced countries. These findings shed new light on the literature that merely considers one specific subject of the relationship and ignores the time and frequency-varying natures in the relationship.

The Feasibility of Reverse Mortgages in Japan

This paper examines the feasibility of reverse mortgages in Japan by utilizing stochastic modeling to characterize the movements of three stochastic variables—interest rates, property values and mortality—underpinning the value of reverse mortgages. We use the yield curve to forecast future interest rates, taking into account the interest arbitrage condition and the term premium. We employ hedonic modelling to develop a house price index for Japan, and then use two times series method—Brownian Motion and Bootstrapping—to forecast house prices. We take the Japanese Ministry of Health, Labor and Welfare life expectancy tables to model mortality. We then integrate these three variables into our default risk estimation model in which we predict the magnitude of potential losses associated with default risk. Our simulation results show that home equity withdrawal rates matter significantly in determining the magnitude of tail risk and that line of credits plan and combination plans increase the feasibility of reverse mortgages in Japan. We also find that the increasing (50bps) risk premiums does not significantly increase the default risk (and of course allows for the buildup of a larger insurance fund). On the one hand, the risk premiums (or spreads) are set to capture the default risk and non-recourse risk. On the other hand, this hedging mechanism will in turn increase the default risk itself by ballooning the unpaid mortgage balance over time, thus generating an endogenous interest rate cycle.

Does the number of holdings in a risk parity portfolio matter?

This empirical study is an endeavor to assess the impact of the number of securities in a risk parity portfolio on its performance. The study focuses on performance analysis of fifty, seventy-five and hundred stocks risk parity portfolio for emerging markets—India and China—and the developed market—the USA. Alpha of the risk parity portfolio has shown sensitivity to the change in the size as a number of holdings of the portfolio. The findings of this empirical study reveal that seventy-five stocks risk parity portfolio is in a sweet-spot for the full sample time period from Dec 2002 to Dec 2014. It not only generates statistically significant superior alpha, but also achieves a similar level of risk diversification as to fifty and hundred stocks portfolio. Testing of sub-periods of the full sample time period, which is coinciding with interest rate cycle, suggests that during the crucial period of financial crisis of 2008, seventy-five stocks portfolio shows the superior performance of alpha, Sharpe ratio and Treynor ratio over fifty stocks and hundred stocks portfolio with a similar level of risk diversification. However, the possibility of superior risk parity portfolio with a marginally higher or lower number than seventy-five stock portfolio cannot be denied.

Financial Cycles Across G7 Economies: A View from Wavelet Analysis

We analyse the cross-country dimension of financial cycles by studying cyclical co-movements in credit, house prices, equity prices and interest rates across the G7 economies. We use wavelet-based statistics to assess at which frequencies cyclical fluctuations and their crosscountry co-movements are important and how these change over time. We show cycles in interest rates and equity prices to be at least as synchronised as cycles in real GDP while cycles in credit and house prices are less synchronised. As a result, cross-country common cycles in equity prices and long-term interest rates account for a larger share of the volatility of these variables at the country level than common cycles in credit aggregates and house prices. A cluster analysis shows a high degree of similarity in the spectral characteristics of cycles in interest rates and equity prices across all countries but less similarities for cycles in credit and house price. For credit and house price cycles country-specific developments turn out to be more important than the common cross-country cycles.

State Dependence of Monetary Policy Across Business, Credit and Interest Rate Cycles

We investigate how the business, credit and interest rate cycles affect the monetary transmission mechanism, using state-dependent local projection methods and data from 18 advanced economies. We exploit the time-series variation within countries, as well as cross-sectional variation across countries, to investigate this issue. We find that the impact of monetary policy shocks on output and most other macroeconomic and financial variables is smaller during periods of economic downturns, high household debt, and high interest rates. We then build a small-scale theoretical model to rationalize these facts. The model highlights the presence of collateral and debt-service constraints on household borrowing and refinancing as a potential cause for state dependence in monetary policy with respect to the business, credit, and interest rate cycles.

Perspectives From the Past for the Federal Reserve’s Monetary Policy and Communication

In this paper we analyze the Federal Reserve’s policy and communication patterns during earlier tightening cycles to gain perspectives into the Federal Reserve’s post-financial crisis monetary policy decisions and communication practices. While each interest rate cycle is unique, as is evident in the post-financial crisis normalization episode, there are regularities that could help inform us about future policy directions. In the post-financial period, the Federal Reserve has placed a great deal of emphasis on policy communication, in particular on its forward guidance, to minimize ambiguity about the future direction of monetary policy. We examine forward guidance during the earlier interest rate cycles and identify some common elements in the Federal Reserve’s communication practices, which would be useful in interpreting the Federal Reserve’s policy actions. This leads us to conclude that it would not be uncharacteristic for the Federal Reserve to suspend its campaign of raising interest rate at this stage of the normalization process, even if inflation risk remains. This underscored the importance of judgment in policy decisions, in part due to uncertainty about the neutral rate of interest, which is a benchmark that the Federal Reserve frequently refers to. In addition, historical trends in economic variables reveal patterns that could assist in evaluating the Federal Reserve’s current and future policy decisions.

Macroeconomic Factors and The Correlation of Stock and Bond Returns: Empirical Evidence from Kenya

This paper investigated how macroeconomic factors affect the correlation between stock and bond returns in Kenya over the past decade (July2006-Dec2015) using the Arbitrage Pricing Theory (APT) and Capital Asset Pricing Model (CAPM) framework for a time series of data. The study aimed to validate that the correlation of stock and bond returns could be explained by their common exposure to macroeconomic factors. The link between the stock-bond correlation and macroeconomic factors was examined using OLS regression model. With the empirical tests aimed at answering the following questions: How does inflation affect the correlation between stock and bond returns in Kenya? How do the interest rates affect the correlation between stock and bond returns in Kenya? How does money supply affect the correlation between stock and bond returns in Kenya? And how does the business cycle affect the correlation between stock and bonds? Secondary data obtained from the Kenya Central Bank, the Nairobi securities exchange and the Kenya bureau of statistics from July 2006 – December 2015 was analyzed. The empirical results confirmed that inflation rate, interest rate and business cycle do have a significant and positive influence on the stock-bond correlation. Money supply was found to have a negative influence on stock bond correlation in this study. The Ordinary Least Square Regression Model confirmed long run relationship between stock-bond correlation and the macroeconomic variables under review. The model was found to be robust because it passed all the diagnostic tests.

Bank lending and loan quality: an emerging economy perspective

This paper analyses how non-performing loans (NPLs) in the emerging economy of India behave through the cycle. We find that a one-percentage point increase in loan growth is associated with an increase in NPLs over total advances (NPL ratio) of 4.1% in the long run with the response being higher during expansionary phases. Furthermore, NPL ratios of banks are found to be sensitive to the interest rate environment and the overall growth of the economy. Notwithstanding differences in management and governance structures, there is a procyclical risk-taking response to credit growth in the case of both public and private banks with private banks being more reactive to changes in interest rate and business cycle conditions.

Real and Financial Cycles in EU Countries - Stylised Facts and Modelling Implications

This paper studies the cyclical properties of real GDP, house prices, credit, and nominal liquid financial assets in 17 EU countries, by applying several methods to extract cycles. The estimates confirm earlier findings of large medium-term cycles in credit volumes and house prices. GDP appears to be subject to fluctuations at both business-cycle and medium-term frequencies, and GDP fluctuations at medium-term frequencies are strongly correlated with cycles in credit and house prices. Cycles in equity prices and long-term interest rates are considerably shorter than those in credit and house prices and have little in common with the latter. Credit and house price cycles are weakly synchronous across countries and their volatilities vary widely – these differences may be related to the structural properties of housing and mortgage markets. Finally, DSGE models can replicate the volatility of cycles in house and equity prices, but not the persistence of house price cycles. JEL Classification: C32, E32, E44

Real and Financial Cycles in EU Countries: Stylised Facts and Modelling Implications

This paper studies the cyclical properties of real GDP, house prices, credit, and nominal liquid financial assets in 17 EU countries, by applying several methods to extract cycles. The estimates confirm earlier findings of large medium-term cycles in credit volumes and house prices. GDP appears to be subject to fluctuations at both business-cycle and medium-term frequencies, and GDP fluctuations at medium-term frequencies are strongly correlated with cycles in credit and house prices. Cycles in equity prices and long-term interest rates are considerably shorter than those in credit and house prices and have little in common with the latter. Credit and house price cycles are weakly synchronous across countries and their volatilities vary widely – these differences may be related to the structural properties of housing and mortgage markets. Finally, DSGE models can replicate the volatility of cycles in house and equity prices, but not the persistence of house price cycles.

ANALISIS PENGARUH KINERJA KEUANGAN, MANAJEMEN RISIKO DAN MANAJEMEN MODAL KERJA TERHADAP RETURN SAHAM

Level stock returns telecommunications in Indonesia is influenced by various factors such as financial performance, risk management and working capital management. The purpose of this research was to analyze the influence of financial performance through parameters Debt to Equity Ratio (DER), Return On Investment (ROI), Current Ratio (CR) dan Total Assets Turn Over (TATO). Risk management using parameters (interest rate) and working capital management using parameters Cash Conversion Cycle (CCC). The population in this study is a telecommunications companies listed in Indonesia Stock Exchange 2010-2013. In analyzing the effect of variable DER, ROI, CR, TATO, ir and CCC using multiple linear regression. The analysis showed that the Debt to Equity Ratio (DER) has effect on stock returns with significant value 0,009, Return on Investment (ROI) has effect on stock returns with significant value 0,006. And Total Asset Turn Over (TATO) has effect on stock returns with significant value 0,025. While the Current Ratio (CR) ,interest rate, and Cash Conversion Cycle not effect on stock returns with significant value 0,403; 0,047; 0,977. All the independent variables simultaneously affect the stock on telecommunication companies.