Portfolio Rebalancing Effects Research Articles

Quantitative Monetary Easing and Risk in Financial Asset Markets

In this paper, we empirically examine the portfolio-rebalancing effects stemming from the policy of “quantitative monetary easing” recently undertaken by the Bank of Japan when the nominal short-term interest rate was virtually at zero. Portfolio-rebalancing effects resulting from the open market purchase of long-term government bonds under this policy have been statistically significant. Our results also show that the portfolio-rebalancing effects were beneficial in that they reduced risk premiums on assets with counter-cyclical returns, such as government and high-grade corporate bonds. But, they may have generated the adverse effects of increasing risk premiums on assets with pro-cyclical returns, such as equities and low-grade corporate bonds. These results are consistent with a CAPM framework in which business-cycle risk importantly affects risk premiums. Our estimates capture only some of the effects of quantitative easing and thus do not imply that the complete set of effects were adverse on net for Japan’s economy. However, our analysis counsels caution in accepting the view that, ceteris paribus, a massive large-scale purchase of long-term government bonds by a central bank provides unambiguously positive net benefits to financial markets at zero short-term interest rates.

Quantitative Monetary Easing and Risk in Financial Asset Markets

In this paper, we empirically examine the portfolio-rebalancing effects stemming from the policy of monetary recently undertaken by the Bank of Japan when the nominal short-term interest rate was virtually at zero. Portfolio-rebalancing effects resulting from the open market purchase of long-term government bonds under this policy have been statistically significant. Our results also show that the portfolio-rebalancing effects were beneficial in that they reduced risk premiums on assets with counter-cyclical returns, such as government and high-grade corporate bonds. But, they may have generated the adverse effects of increasing risk premiums on assets with pro-cyclical returns, such as equities and low-grade corporate bonds. These results are consistent with a CAPM framework in which business-cycle risk importantly affects risk premiums. Our estimates capture only some of the effects of quantitative easing and thus do not imply that the complete set of effects were adverse on net for Japan's economy. However, our analysis counsels caution in accepting the view that, ceteris paribus, a massive large-scale purchase of long-term government bonds by a central bank provides unambiguously positive net benefits to financial markets at zero short-term interest rates.

Big Fish in Small Ponds: The Trading Behavior and Price Impact of Foreign Investors in Asian Emerging Equity Markets

AbstractThis paper analyzes a new dataset for the aggregate daily trading of all foreign investors in six Asian emerging equity markets and provides two new findings. First, foreigners' flows into several markets show positive feedback trading with respect to global, as well as domestic, equity returns. The nature of this trading suggests it is due to behavioral factors or foreigners extracting information from recent returns, rather than portfolio rebalancing effects. Second, the price impacts associated with foreigners' trading are much larger than earlier estimates. The results suggest that foreign investors and external conditions have a larger impact on emerging markets than implied by previous work.

The Effects of the Bank of Japan's Zero Interest Rate Commitment and Quantitative Monetary Easing on the Yield Curve: A Macro-Finance Approach

This paper provides an empirical investigation of monetary policy in Japan in the zero interest rate environment that has held sway since 1999. In particular, we focus on the effects of the zero interest rate commitment and of quantitative monetary easing on medium- to long-term interest rates in Japan. In the study we apply a version of the macro-finance approach, involving a combination of estimation of a structural macro-model and calibration of time-variant parameters to the yield curve observed in the market. This enables us to decompose interest rates into expectations and risk premium components and simultaneously to extract the market's perception of the Bank of Japan's (BOJ's) willingness to carry on its zero interest rate policy. In the analysis we make clear the counterfactual policy that would have been practiced in the absence of the actual policies followed by the BOJ since 1999. From this analysis, we tentatively conclude that the BOJ's monetary policy since 1999 has functioned mainly through the zero interest rate commitment, which has led to declines in medium- to long-term interest rates. We also find some evidence that, up until the end of 2003, raising the reserve target may have been perceived as a signal indicating the BOJ's accommodative policy stance although the size of the effect is not large. The portfolio rebalancing effect - either by the BOJ's supplying ample liquidity or by its purchases of long-term government bonds - has not been found to be significant.

Quantitative Monetary Easing and Risk in Financial Asset Markets

In this paper, we empirically examine the portfolio-rebalancing effects stemming from the policy of "quantitative monetary easing" recently undertaken by the Bank of Japan when the nominal short-term interest rate was virtually at zero. Portfolio-rebalancing effects resulting from the open market purchase of long-term government bonds under this policy have been statistically significant. Our results also show that the portfolio-rebalancing effects were beneficial in that they reduced risk premiums on assets with counter-cyclical returns, such as government and high-grade corporate bonds. But, they may have generated the adverse effects of increasing risk premiums on assets with pro-cyclical returns, such as equities and low-grade corporate bonds. These results are consistent with a CAPM framework in which business-cycle risk importantly affects risk premiums. Our estimates capture only some of the effects of quantitative easing and thus do not imply that the complete set of effects were adverse on net for Japan's economy. However, our analysis counsels caution in accepting the view that, ceteris paribus, a massive large-scale purchase of long-term government bonds by a central bank provides unambiguously positive net benefits to financial markets at zero short-term interest rates.

Big Fish in Small Ponds: The Trading Behavior and Price Impact of Foreign Investors in Asian Emerging Equity Markets

Daily data for foreign investors' trading in six Asian emerging equity markets provide two new findings. First, foreigners' flows into several markets show positive-feedback trading with respect to global, as well as domestic, equity returns. The nature of this trading suggests it is due to behavioural factors or foreigners extracting information from recent returns, rather than portfoliorebalancing effects. Second, the price impacts associated with foreigners' trading are much larger than earlier estimates, and would be consistent with permanent price pressures from demand shocks. The results suggest that foreign investors and external conditions have a larger impact on emerging markets than implied by previous work.

The Asset Allocation Of Emerging Market Mutual Funds

Benchmark following and portfolio rebalancing effects have often been cited when trying to explain international contagion phenomena. Using a dataset containing the country allocation of individual dedicated emerging market equity funds, we assess the relevance of mean-variance optimization and benchmark following, finding strong evidence for both. We also present a framework to systematically extract useful information about market expectations from funds' holdings.

The Asset Allocation of Emerging Market Mutual Funds

Benchmark following and portfolio rebalancing effects have often been cited when trying to explain international financial contagion phenomena. Using a dataset containing the country allocation of individual dedicated emerging market equity funds, we assess the relevance of mean-variance optimization and benchmark following, finding strong evidence for both. We also present a framework to systematically extract useful information about market expectations from funds' holdings.

A Portfolio View of the U.S. Current Account Deficit

FROM 1971 TO 1982 THE U.S. current account balance as a share of U.S. GNP averaged roughly zero.(1) Starting in 1983, however, the United States experienced increasingly large current account deficits, which reached 3.3 percent and 3.4 percent of GNP in 1986 and 1987, respectively. This tendency toward larger deficits was reversed gradually during the rest of the decade, and by 1991 the current account was near zero again. But starting in 1993 the current account again began to record increasingly large deficits, which grew to 3.6 percent of GNP in 1999 and 4.4 percent in 2000. This history of the current account prompts several questions: What is the source of the large current account deficits of the 1990s? Are they likely to remain with us indefinitely? If not, should we expect them to fade away slowly as they did in the 1980s? Or should we expect instead a sharp reversal in the near future? In this essay I interpret these trends in the U.S. current account from a perspective that focuses on the behavior of the country portfolio. The country portfolio is defined as the sum of all productive assets located in the United States, plus the U.S. net foreign asset position (that is, the sum of all claims on foreign assets held by U.S. residents minus the sum of all claims on U.S. assets owned by foreign residents). By the composition of the U.S. portfolio I mean the share of the net foreign asset position in it.(2) According to the portfolio view, it is useful to separate changes in the current account into two components: changes in the size of the country portfolio, which I call portfolio growth effects, and changes in the composition of the country portfolio, or portfolio rebalancing effects. A simple application of this approach reveals a clear picture: the recent current account deficits are mostly the manifestation of the spectacular increase in U.S. wealth experienced in the 1990s. Contrary to a widely held belief, these deficits do not reflect a rebalancing of portfolios toward U.S. assets and away from foreign assets. A natural question follows: Why did U.S. wealth increase so much in the 1990s? I explore two alternative hypotheses. The first views the increase in wealth as reflecting a rapid accumulation of an intangible form of capital. The second is based on the notion that the 1990s were characterized by the appearance and growth of a bubble in the U.S. stock market. Although both explanations exhibit interesting elements, neither is fully satisfactory. Our inability to account for the growth in wealth makes the task of predicting the future direction of the U.S. current account quite difficult, if not impossible. Nevertheless, each of these stories has a different ending, and I discuss them below.(3) A Portfolio View of the Current Account The point of departure for a portfolio view of the current account is the celebrated mean-variance theory of Harry Markowitz and James Tobin.(4) According to this theory, investors choose their portfolios by optimally trading off risk and return. The optimal or mean-variance-efficient portfolio contains the risk-free asset and an optimal combination of risky assets (OCRA). A strong result of the theory is that the OCRA is the same for all investors with access to the same menu of assets, regardless of their attitudes toward risk and their level of wealth. That is, the share of each asset in the OCRA depends only on the distribution of asset returns. Another strong result of the theory is that the weights that mean-variance investors assign to the risk-free asset and the OCRA depend only on their risk aversion and the distribution of asset returns. They do not depend on the investors' wealth.(5) Moving from the optimal investor portfolio to the average or country portfolio requires an additional assumption, namely, that the average risk aversion and the distribution of asset returns are both independent of wealth. This is a strong assumption, and its validity is an empirical issue that is far from settled. …

Asymmetric information and the predictability of real estate returns.

This article examines the relation between systematic price changes and the heterogeneity of investors' information sets in real estate asset markets. The empirical implications rely on a theoretical economy in which information asymmetry alters the dynamic relation between returns and trading volume. We employ a filter-rule methodology to determine predictability in returns and augment the return-based conditioning set with trading volume. The additional conditioning information is necessary since the model is underspecified when predictability is based on returns alone. Our results provide new insight into the coexistence of informational and noninformational exchange in the speculative markets for real estate assets. Specifically, we find that the predictability of real estate returns is generally more indicative of portfolio rebalancing effects than an adverse-selection problem. These results are unique in addressing the time-variation in information asymmetry.