Real Bond Yields Research Articles

Corporate Real Estate Values and Bond Yield Spreads

Corporate Real Estate Values and Bond Yield Spreads

Ambiguity, Nominal Bond Yields, and Real Bond Yields

This paper presents an equilibrium bond-pricing model that jointly explains the upward-sloping nominal and real yield curves and the violation of the expectations hypothesis. Instead of relying on the inflation risk premium, the ambiguity-averse agent faces different amounts of Knightian uncertainty in the long run versus the short run; hence the model-implied nominal and real short rate expectations are upward-sloping under the agent’s worst-case equilibrium beliefs. The expectations hypothesis roughly holds under investors’ worst-case beliefs. The difference between the worst-case scenario and the true distribution makes realized excess returns on long term bonds predictable.

Stock vs. Bond yields and demographic fluctuations

Abstract This paper analyzes the strong comovement between real stock and nominal bond yields at generational frequencies. Using a stochastic overlapping generations model with cash-in-advance constraints, we show that the simulated life-cycle patterns in savings behavior make both real stock and nominal bond yields comove with the changing population age structure. These persistent comovements account for the equilibrium relation between stock and bond markets. A stochastic Fisher decomposition of nominal bond yields reveals that, while having a moderate effect on both the inflation risk premium and expected inflation, demographic changes affect nominal yields mainly through real bond yields. Using both U.S. data and a cross-country panel, we find empirical support for these theoretical predictions. Finally, we show that the strength of the demographic effect on real yields explains cross-country differences in the comovement between stock and bond markets, while alternative demographic channels fail to explain such cross-country heterogeneity.

Examining the Effects of the European Monetary Union Using Propensity Score Matching

We examine the treatment effects of joining the European monetary union on macroeconomic outcomes in the member countries. Specifically, we apply propensity score analysis to mitigate the self-selection bias associated with the non-random nature of joining the union. The findings suggest joining the union leads to decline in inflation, inflation volatility, real GDP growth and bond yield for the post-EMU formation period. The treatment effects on bond yield and debt show divergent pattern in core and periphery countries after the financial crisis. The bond market in the southern EMU countries benefited disproportionately in the pre-crisis period in terms of lower bond yields.

Equity/bond yield correlation and the FED model: evidence of switching behaviour from the G7 markets

This paper considers how the strength and nature of the relation between the equity and bond yield varies with the level of the real bond yield. We demonstrate that at low levels of the real bond yield, the correlation between the equity and bond yields turns negative. This arises as the lower bond yield implies heightened macroeconomic risk (e.g. deflation and economic stagnation) and causes equity and bond prices to move in opposite directions. The FED model relies on a positive relation for its success in predicting future returns. Thus, we argue that the mixed empirical evidence regarding the FED model arises due to this switch in correlation behaviour. We present supportive evidence for the switching relation and its link to the level of the bond yield using linear and nonlinear smooth transition panel regression techniques for the G7 markets. The results presented here should be of interest to market practitioners who may wish to use the FED model to aid market timing decisions and for academics interested in understanding the interrelations between markets.

Ambiguity, Nominal Bond Yields, and Real Bond Yields

This paper presents an equilibrium bond-pricing model that jointly explains the upward-sloping nominal and real yield curves and the violation of the expectations hypothesis. Instead of relying on the inflation risk premium, the ambiguity-averse agent faces different amounts of Knightian uncertainty in the long run versus the short run; hence, the model-implied nominal and real short rate expectations are upward sloping under the agent’s worst-case equilibrium beliefs. The expectations hypothesis roughly holds under investors’ worst-case beliefs. The difference between the worst-case scenario and the true distribution makes realized excess returns on long-term bonds predictable. (JEL D81, D84, E23, E31, E43, E44, G12)

Oil Price, Bond Return, and Breakeven Inflation

Compared with stocks, bonds are more directly affected by fluctuations in oil prices through the expected inflation component in nominal bond yields. Surprisingly, prior literature finds little predictive power of oil price changes on bond excess returns. This finding is counter intuitive, especially given the strong predictive relationship between oil price changes and equity risk premium. Using oil supply, global demand, and oil-specific demand shocks, estimated from a structural VAR model of oil price changes, this paper provides new empirical evidence - the oil price changes driven by global demand shocks predict negative real bond risk premium and positive inflation risk premium. Since these two effects offset each other, we observe insignificant effect on the bond risk premium. A two-sector New Keynesian model shows theoretically that real bond yield, breakeven inflation, and nominal bond yield respond differently to oil supply and demand shocks.

Improving U.S. Stock Return Forecasts: A “Fair-Value” CAPE Approach

The accuracy of U.S. stock return forecasts based on the cyclically-adjusted P/E (CAPE) ratio has deteriorated since 1985. A primary reason has been that traditional CAPE regressions assume the CAPE ratio reverts mechanically to its long-run average, regardless of the macroeconomic environment. In this article, the authors propose an enhancement to standard CAPE-based forecasts that conditions mean reversion in the CAPE ratio on real (not nominal) bond yields, expected inflation rates, and financial volatility in a VAR model. The forecasted results are promising for both real and nominal returns, with out-of-sample forecast errors approximately 50% lower than traditional approaches. The differences are economically meaningful and statistically significant over the forecast period examined. At present, low real bond yields imply low real earnings yields and an above-average “fair-value” CAPE ratio. Nevertheless, with Shiller’s CAPE ratio now well above its fair value, the model proposed by the author predicts nominal U.S. stock returns centered near 5% over the next decade.

Improving U.S. Stock Return Forecasts: A 'Fair-Value' Cape Approach

The accuracy of U.S. stock return forecasts based on the cyclically-adjusted P/E (CAPE) ratio has deteriorated since 1985. The issue is not the CAPE ratio, but CAPE regressions that assume it reverts mechanically to its long-run average. Our approach conditions mean reversion in the CAPE ratio on real (not nominal) bond yields, reducing out-of-sample forecast errors by as much as 50%. At present, low real bond yields imply low real earnings yields and an above-average “fair-value” CAPE ratio. Nevertheless, with Shiller’s CAPE ratio now well above its fair value, our model predicts muted U.S. stock returns over the next decade. We believe that our framework should be adopted by the investment profession when forecasting stock returns for strategic asset allocation.

Pricing of Bonds and Equity when the Zero Lower Bound is Relevant

This paper investigates the joint dynamics of nominal bond yields, real bond yields and dividend yields from the 80s up to the aftermath of the financial crisis by mapping them on a set of macro factors. It builds on an existing discrete time affine Gaussian model of the term structure model of nominal bonds, real bonds and equity and extends it by three important innovations. Firstly, allowing for structural shifts in inflation expectations. Secondly, accounting for the relevance of the zero lower bound in the period after 2008 by modelling a so-called shadow rate and deriving asset prices by explicitly considering the zero lower bound. Finally, calculating the standard errors to correctly capture the multi-step nature of the estimation process, which results in substantially larger standard errors than previously reported for the model. We achieve statistically signicant risk premia by imposing restrictions on the matrix of risk premia. Taken together, these modifications allow to better model asset prices also during the financial crisis and the ensuing economic environment of sluggish growth, low inflation rates, interest rates close to zero and quantitative easing. JEL Classification: C13, E43, G12

Equity-Bond Returns Correlation and the Bond Yield: Evidence of Switching Behaviour from the G7 Markets

Aktien-Anleihen Korrelation und Anleiherenditen: Nachweis von Wechselverhalten in den G7 Märkten In diesem Beitrag wird die Korrelation zwischen den realen Aktienrenditen und denjenigen von Staatsanleihen innerhalb der G7-Länder analysiert. Die etablierte Finanzmarkttheorie lässt eine positive Korrelation der Renditen erwarten. Allerdings zeigt die empirische Evidenz das Auftreten einer negativen Korrelation während bestimmter Zeitabschnitte. Die Korrelation selbst weist einen positiven Zusammenhang mit der (realen) Anleiherendite auf. Zu diesem Resultat führt die Anwendung von Panel- sowie individuellen Regressionen innerhalb der G7-Märkte. Für gewöhnlich wird eine höhere (niedrigere) Anleihenrendite mit sowohl fallenden (steigenden) Aktien- als auch Rentenkursen in Zusammenhang gebracht. Allerdings können niedrige respektive fallende Renditen dazu führen, dass die Anleihepreise steigen, während die Aktienkurse nachgeben. Grund hierfür ist, dass eine solche Konstellation makroökonomische Risiken in Form einer möglichen Deflation und / oder wirtschaftlichen Stagnation impliziert. Darüber hinaus sprechen die Ergebnisse dafür, dass eine reale Staatsanleihenrendite von weniger als 3 % mit negativen Korrelationen der Renditen einhergeht. Aus Sicht eines Investors stützt diese Erkenntnis das Auftreten positiver Diversifikationseffekte bei niedrigem Realzins. Darüber hinaus hat sie Auswirkungen auf Bewertungsmodelle für Aktien und Anleihen.

Asset Pricing at the Zero Lower Bound

In a New-Keynesian model subject to the zero lower bound (ZLB), constrained monetary policy endogenously results in time-varying equity risk premia and equity-bond market correlations. Liquidity traps at the ZLB are characterized by negatively skewed and increasingly uncertain consumption growth, labor growth, and inflation. Investors with recursive preferences price the liquidity traps, resulting in rising equity risk premiums. Real bond yields and equity returns become negatively correlated at the ZLB, while positive in normal times. The model provides a general equilibrium foundation for 1) the time-varying comovement amongst macroeconomic quantities and asset prices observed during the the Great Recession and 2) why real bonds ceased to provide investors with insurance at the ZLB, precisely when they valued it most.

Labor Rigidity, Inflation Risk and Bond Returns

This paper exploits information from the variance-ratios of macroeconomic variables to infer about the short and long-run components of dividend risk and ination risk. While labor rigidity shifts dividend risk towards the short horizon, it also reveals {by means of labor-share variation{ the component of ination risk which is correlated with fundamentals. A simple general equilibrium model with labor rigidity can explain how ination interacts with the real growth and the labor-share, as well as many patterns of the term-structures of real and nominal bond yields. The model is robust to many properties of equity returns.

Determinants of the AUD/USD Exchange Rate and Policy Implications

This paper examines short-run determinants of the Australian dollar/U.S. dollar (AUD/USD) exchange rate based on a simultaneous-equation model. Applying the EGARCH method, the paper finds that the AUD/USD exchange rate is positively associated with the 10-year U.S. real government bond yield, U.S. real GDP, the U.S. real stock price and the expected exchange rate and negatively influenced by the Australian real government bond yield, Australian real GDP, and the real Australian stock price.

Labor Rigidity, Inflation Risk and Bond Returns

This paper exploits information from the variance-ratios of macroeconomic variables to infer about the short and long-run components of dividend risk and ination risk. While labor rigidity shifts dividend risk towards the short horizon, it also reveals {by means of labor-share variation{ the component of ination risk which is correlated with fundamentals. A simple general equilibrium model with labor rigidity can explain how ination interacts with the real growth and the labor-share, as well as many patterns of the term-structures of real and nominal bond yields. The model is robust to many properties of equity returns.

Determinants of the Indian rupee/US dollar exchange rate and policy implications

Based on a simultaneous-equation model of demand and supply, this paper finds that the Indian rupee/US dollar (INR/USD) exchange rate is positively associated with the US real government bond yield, Indian real GDP, the US real stock price and the expected INR/USD exchange rate and is negatively affected by the Indian real interest rate, US real GDP and the Indian real stock price. The finding that a higher Indian real interest rate would cause the Indian rupee to appreciate against the US dollar is consistent with the traditional view.

Do demographic changes matter? A cross-country perspective

We explore the inflation-adjusted yields on benchmark 10-year government bonds in seven developed countries to see if both demographic and non-demographic variables can explain why real bond yields are so low.We find that over the last 60 years there has been a regime shift in the late-1980s that radically altered output growth in major economies as dependency ratios declined. Because of this change we used two time periods for our models: low-frequency annual data from 1950 to 2012 and quarterly data from 1990 to 2013. We show that population age ratios are important as a determinant in the demand for financial assets. In this paper we also introduce a global proxy for quantitative easing (QE). We find that in developed markets in Europe and North America the QE has lowered bond yields by approximately 50–100bps since the global credit crisis began.

It Takes a Regime Shift: Recent Developments in Japanese Monetary Policy through the Lens of the Great Depression

Last week, we witnessed one of the most exciting developments in monetary policymaking since the 1930s. The Japanese central bank staged an honest-to-goodness regime shift. The Bank of Japan went beyond vague promises and cheap talk. As I will describe in more detail later, it took dramatic actions and pledged convincingly to do whatever it takes to end deflation in Japan. The theoretical reasons why this regime shift may be important are well understood by economists. Persistent deflation and anemic growth suggest that Japan continues to suffer from a shortfall of demand. But their policy interest rate is already at the zero lower bound. Furthermore, riskier, long-term rates are also very low— suggesting that unconventional policies such as large-scale asset purchases are unlikely to do much to further reduce nominal rates. As discussed by Paul Krugman, Gauti Eggertsson and Michael Woodford, and others, if unconventional monetary policy can raise expected inflation, this can push down real interest rates even though nominal rates cannot fall. 1 This, in turn, can raise aggregate demand by stimulating interest

Inflation Expectations, Real Rates, and Risk Premia: Evidence from Inflation Swaps

We develop a model of nominal and real bond yield curves that has four stochastic drivers but seven factors: three factors primarily determine the cross-section of yields, whereas four volatility factors solely determine risk premia. The model is estimated using nominal Treasury yields, survey inflation forecasts, and inflation swap rates and has attractive empirical properties. Time-varying volatility is particularly apparent in short-term real rates and expected inflation. Also, we detail the different economic forces that drive short- and long-term real and inflation risk premia and provide evidence that Treasury inflation-protected securities were undervalued prior to 2004 and during the recent financial crisis.

Breakeven inflation rates and their puzzling correlation relationships

It is generally assumed that the two Fisher components of the interest rate – the real interest and the inflation – evolve independently over time, considering that they are driven by unrelated economical events. However, the market pricing of those components deduced from newly-available bond data does not provide conclusive evidence. While studying the price behaviour of inflation-linked (real) bonds beside nominal bonds in the major fixed-income markets, we observe that the Real Bond Yields (RBY) and the yield differentials, the Breakeven Inflation Rates (BEIR), have the propensity to be positively correlated between each other across the various countries, yet are pushed into a negative correlation relationship due to market-related price distortions. As long as those distortions are local, the net result is near-zero correlation within countries; when they become global, as in the heat of the current crisis, the correlations turn negative worldwide. In this article insight is gained by taking an innovative worldwide study approach and thanks to revealing crisis period events.