US Bond Research Articles

Minimum Connectedness Portfolios and the Market for Green Bonds: Advocating Socially Responsible Investment (SRI) Activity

Socially responsible investment (SRI) practices are increasingly widely adopted, and moving into mainstream investment activity. Among the suite of instruments available to responsible investors is a fixed-income offering known as a green bond - a specialized bond in which the use of proceeds are strictly earmarked for projects with an explicit ‘green’ orientation. The market for green bonds was established in 2007, and in recent years is achieving a phase of maturity. Notwithstanding this, there is as yet scant evidence or empirical insights around their potential value to investors. Here we question whether green bonds have a (value-enhancing) role to play in a balanced fixed-income investment portfolio. We phrase our analysis around international bond indices, for green versus black bonds in the three major market regions for green bonds, namely the US, Europe and China. A time-varying parameter vector auto-regression (TVP-VAR) econometric framework is applied to daily data - spanning July 2016 to April 2019 - to examine aggregate network, and pairwise dynamics as they have evolved through time and illustrate the evolving nature of connectedness between these core bond-market benchmarks. Following this, bond portfolios are constructed with dynamic weighting schemes (including a novel ‘minimum connectedness’ portfolio) to question, if, when and to what extent green bonds are part of an international fixed-income investor’s portfolio. The results indicate a non-trivial role for green bonds, with weights ranging from approximately 40% to 80% depending on time, and portfolio construction choice. Chinese green bonds typically have the largest weight of the green bond indices, especially under minimum-variance portfolios, while in the preferred ‘minimum connectedness’ portfolio there is a much more balanced representation of US, European and Chinese green bonds. Our analysis contributes unique evidence to the literature on the role of SRI practices as a complement to mainstream investment.

Multiple Chains Hidden Markov Models for Bivariate Dynamical Systems

We present a new modelling framework for the bi-variate hidden Markov model. The proposed specification is composed by five latent Markovian chains which drive the evolution of the parameters of a bi-variate Gaussian distribution. The maximum likelihood estimator is computed via an expectation conditional maximization algorithm with closed form conditional maximization steps, specifically developed for our model. Identification of model parameters, as well as consistency and asymptotic Normality of the maximum likelihood estimator are discussed. Finite sample properties of the estimator are investigated in an extensive simulation study. An empirical application with the bi-variate series of US stocks and bond returns illustrates the benefits of the new specification with respect to the standard hidden Markov model.

Modeling the density of US yield curve using Bayesian semiparametric dynamic Nelson-Siegel model

This paper proposes the Bayesian semiparametric dynamic Nelson-Siegel model for estimating the density of bond yields. Specifically, we model the distribution of the yield curve factors according to an infinite Markov mixture (iMM). The model allows for time variation in the mean and covariance matrix of factors in a discrete manner, as opposed to continuous changes in these parameters such as the Time Varying Parameter (TVP) models. Estimating the number of regimes using the iMM structure endogenously leads to an adaptive process that can generate newly emerging regimes over time in response to changing economic conditions in addition to existing regimes. The potential of the proposed framework is examined using US bond yields data. The semiparametric structure of the factors can handle various forms of non-normalities including fat tails and nonlinear dependence between factors using a unified approach by generating new clusters capturing these specific characteristics. We document that modeling parameter changes in a discrete manner increases the model fit as well as forecasting performance at both short and long horizons relative to models with fixed parameters as well as the TVP model with continuous parameter changes. This is mainly due to fact that the discrete changes in parameters suit the typical low frequency monthly bond yields data characteristics better.

A Decomposition of International Capital Flows

We propose a method to break down capital flows into portfolio growth and portfolio reallocation components and apply it to data on US equity and bond outflows. The decomposition is part of an integrated approach that decomposes purchases of any asset into portfolio growth and reallocation components. US equity and bond outflows depend not just on portfolio growth and the reallocation between US and foreign equity and bonds, but also on reallocation decisions higher up on the decision tree. This includes reallocation between portfolio and non-portfolio assets and between equity and bonds. We also consider the decomposition of US equity and bond outflows to individual foreign countries. The data shed light on the importance of the various components in accounting for capital flows over both the short and long run.

This Time Is Different, but It Will End the Same Way: Unrecognized Secular Changes in the Bond Market since the 2008 Crisis That May Precipitate the Next Crisis

The US bond market had over $42.39 trillion of outstanding debt at the end of the third quarter of 2018, eclipsing the US stock market’s approximately $30 trillion in market capitalization. The sheer size of the bond market provides ample opportunities, as well as risks, for institutional investors. Some of these risks escape investors’ radar because of the nature of fixed income securities: low transparency, illiquidity, and over-the-counter (OTC) trading. In this article, the authors present our concerns regarding five secular changes wrought by the over-regulation of the marketplace after the financial crisis of 2008 and investors’ persistent thirst for yield. Further, although painful lessons were gleaned after the punishing 2008 financial crisis, the authors present empirical evidence that suggests that many sectors, such as auto loans and collateralized loan obligations, that were largely unscathed by this crisis may be at risk in the next downturn. This article is based on original data sources and academic research. The authors are in continuing dialogue with other experts that may further the research, and welcome interested parties to get in contact. <b>TOPICS:</b>Financial crises and financial market history, statistical methods <b>Key Findings</b> • Lack of market-making and other regulatory changes that will impede price discovery in the next downturn. • Masking of the deterioration of underlying collateral and rearview mirror analysis. • New versions of the old games played by the rating agencies. • Explosion in number of Asset-Liability mismatched structures. • Regulatory changes in compliance of financial institutions.

Measuring Bond Investors’ Risk Appetite Using the Interest Rate Term Structure

The distribution of term premia includes additional information beyond that contained in the traditional three-parameter decomposition of the Treasury yield curve. The author finds that the position and the size of the curvature hump are both important. A yield curve hump positioned at longer maturities appears to be consistent with lengthier time horizons of investors and with more risk-seeking behavior. The author finds that this new parameter Granger drives both future US economic activity and bond returns. TOPICS:Fixed income and structured finance, fixed-income portfolio management, statistical methods

The US Bond Market before 1926: Investor Total Return from 1793, Comparing Federal, Municipal and Corporate Bonds Part II: 1857 to 1926

US securities markets took root after Alexander Hamilton’s refunding of the Federal debt in the early 1790s. Accordingly, a market in bonds has been in operation in the US for over two centuries. Until recently, however, little was known about bond market returns prior to 1857. This paper focuses on investor holding period returns, using newly compiled data on bond prices, rather than focusing on the movement of yields, as in Homer (1963) and Macaulay (1938). It incorporates the relatively familiar Treasury securities from the years before President Andrew Jackson paid off the debt in 1835, but also includes state and city debt, which ballooned beginning in the 1820s, as well as corporate debt, from its beginnings about 1830 to its explosion after 1850. I find that all three classes of bonds provided investors with similar total returns prior to 1857, excepting a brief period in the 1840s when state securities plunged before recovering. I also find that over the entire 19th century, real bond returns considerably exceeded the long-term average return of 3.6% proposed for bonds in Siegel (2014). In explaining these high bond returns I identify problems with Siegel’s data sources, notably Homer’s mistaken interpretation of Macaulay’s data. I further find that in these early years, bonds sometimes out-performed stocks over periods of several decades, again contrary to Siegel’s thesis. The paper considers the implications of a demonstration that stocks and bonds performed differently in the nineteenth century as compared to the twentieth century. [Some results in this paper have been further revised and better integrated with subsequent work, see revision notes following this Abstract.]

Flight-to-safety and the risk-return trade-off: European evidence

This paper investigates flight-to-safety from stocks to bonds in six European markets. We use quantile regressions to identify flight-to-safety episodes. The conditional risk-return trade-off on the stock markets is negative. Flight-to-safety episodes strengthen the negative trade-off. The effects of flight-to-safety episodes on the trade-off are qualitatively similar for own country flight-to-safety episodes, for flight from own country stock market to the US bond market, and for US flight-to-safety episodes. The strength of the trade-off is strongest for US flight-to-safety episodes. Flight-from-safety has the opposite effect on the trade-off.

The effect of inflation, US bond yield, and exchange rate on Indonesia bond yield

Indonesia sovereign bonds are investment graded bonds, therefore, it will have global exposure and it will be more interlinked with global market condition. The purpose of this research is to examine the impacts of US bond yield, exchange rate, and inflation on Indonesian bond yield. Our result conclude that based on Vector Error Correction Model there are long run causality from inflation, US 10 year bond yield, and USD/IDR exchange rate to Indonesia 10 year bond yield. There are also short-run causality from inflation and US 10 year bond yield to Indonesia 10 year bond yield. Based on impulse response function, Indonesia 10 year bond yield respond permanently to changes in US 10 year bond yield. Based on Granger causality we also reveal that inflation and US 10 year bond yield can cause Indonesia 10 year bond yield. US 10 year bond yield has a larger impact than inflation when it comes to affecting Indonesia 10 year bond yield

Investing with Cryptocurrencies—a Liquidity Constrained Investment Approach*

AbstractCryptocurrencies have left the dark side of the finance universe and become an object of study for asset and portfolio management. Since they have low liquidity compared to traditional assets, one needs to take into account liquidity issues when adding them to a portfolio. We propose a Liquidity Bounded Risk-return Optimization (LIBRO) approach, which is a combination of risk-return portfolio optimization under liquidity constraints. Cryptocurrencies are included in portfolios formed with stocks of the S&amp;P 100, US Bonds, and commodities. We illustrate the importance of the liquidity constraints in an in-sample and out-of-sample study. LIBRO improves the weight optimization in the sense that it only adds cryptocurrencies in tradable amounts depending on the intended investment amount. The returns greatly increase compared to portfolios consisting only of traditional assets. We show that including cryptocurrencies in a portfolio can indeed improve its risk–return trade-off.

Hedge Fund Strategies, Performance &amp;amp; Diversification: A Portfolio Theory &amp;amp; Stochastic Discount Factor Approach

For 5,500 North American hedge funds following 11 different strategies, we analyse the stand-alone performance of these strategies using a stochastic discount factor approach. Employing the same data, we then consider the diversification benefits of each hedge fund strategy when combined with a portfolio of US equities and bonds. We compute the out-of-sample Black-Litterman portfolios, with Bayes-Stein, higher moments, simulations, desmoothed data and allowance for regimes as robustness checks. All but two hedge fund strategies out-perform the market as stand-alone investments; and all but one provide significant diversification benefits. The higher is an investor’s risk aversion, the more beneficial is diversification into hedge funds.

This Time Is Different, but It Will End the Same Way: Unrecognized Secular Changes in the Bond Market since the 2008 Crisis That May Precipitate the Next Crisis

The US bond market had over $42.39 trillion of outstanding debt at the end of the third quarter of 2018, eclipsing the US stock market’s approximately $30 trillion in market capitalization. The sheer size of the bond market provides ample opportunities, as well as risks, for institutional investors. Some of these risks escape investors’ radar because of the nature of fixed-income securities: low transparency, illiquidity, and over-the-counter (OTC) trading. In this paper, we present our concerns regarding five secular changes brought up by the over-regulation of the marketplace after the financial crisis of 2008 and investors’ persistent thirst for yield. Further, while painful lessons were gleaned after the punishing 2008 financial crisis, we present empirical evidence that suggests that many sectors, such as the auto loans and collateralized loan obligations, that were largely unscathed by this crisis may be at risk in the next downturn. This paper is based on original data sources and academic research. The authors are in continuing dialogue with other experts that may further the research, and welcome interested parties to get in contact.

Bond–Equity Yield Ratio Market Timing in Emerging Markets

This article investigates the market timing ability of the bond–equity yield ratio (BEYR) from an international investor perspective. Consolidating data on emerging markets, we document no major international evidence that BEYR-based investing strategies, namely extreme values, thresholds and moving averages, provide higher risk-adjusted returns than benchmark buy-and-hold portfolios. However, we develop new augmented BEYR indicators by introducing the notion of US bonds as a safe investment relative to emerging market stocks and bonds. Dynamic strategies based on our augmented BEYR indicators produce significant gains in risk-adjusted returns compared with traditional BEYR and buy-and-hold benchmark strategies. JEL Classifications: G11, G12, G15

An Investigation on the Volatility of Cryptocurrencies by means of Heterogeneous Panel Data Analysis

Cryptocurrencies have emerged about ten years ago as a new form of currency and have attracted much attention since they depend on a fully decentralized system, and so their transactions are very fast and have zero transaction cost. Therefore, character of cryptocurrencies and their volatility have been discussed widely by investors, policymakers and economists in recent years. From this point of view, this study aims to explain the price volatility of cryptocurrencies with macro-financial indicators, and thereby, the effects of S&P 500 stock market index, gold price, oil price, 2-year benchmark US Bond interest rate and US Dollar index on the prices of four major cryptocurrencies, Bitcoin, Litecoin, Ethereum, and Ripple, are investigated. The study comprises a panel data analysis applied to daily data over the period of August 2016 – April 2019, and analysis results show that increases in gold price, oil price and S&P 500 index raise the prices of cryptocurrencies, while increases in 2-year benchmark US Bond interest rate and US Dollar index cause to a fall. This adverse effects of the US Dollar index and US Bond interest rate on the prices of cryptocurrencies indicates that when the value of US Dollar and US Bond yield decrease investors prefer to invest in cryptocurrencies as alternative investment instruments. On the other hand, cryptocurrencies move with a similar trend of stock market index, gold price and oil price which are overall market indicators. Thereby, findings of this study show that cryptocurrencies behave more like an investment instrument than a currency, and prices of these financial assets interact with significant macro-financial indicators.

The Performance of US Bond Mutual Funds

We evaluate the performance of the US bond mutual fund industry using a comprehensive sample of bond funds over a long time period from January 1998 to February 2017. In this one study, we examine bond fund selectivity, market timing and performance persistence. We evaluate bond funds relative to their self-declared benchmarks and in terms of both gross-of-fee returns and net-of-fee returns. We document considerable abnormal performance among funds both to the fund (gross returns) and to the investor (net returns). Bond fund performance is found to be superior in the post financial crisis period. However, past strong performance cannot be relied upon to predict future performance. Finally, while some funds exhibit market timing ability; we find a predominance of negative market timing among US bond mutual funds.

PRICE RELATIONSHIPS BETWEEN BOND MARKETS

Introduction. The strengthening of globalization processes leads to a greater integration of the domestic financial market into the global financial market, especially bond market. Ukraine is under significant influence of world economic processes. In this context the impact that has on the state of the domestic market of Ukraine our financial market, as well as the actions of American financial regulators. On the background of the formation of excessive debt structure of the global financial market, including the US market, the financial market of Ukraine in recent time, there is also the nature of the debt market which is a key financial instrument is bonds, i.e. government bonds. Not less important and of the dual influence of the two basic segments of the financial market between market shares and bonds that affects the efficiencyof capital investors. The purposeis the research of the relationships that are formed between the markets of shares and bonds on the example of financial markets of the USA and Ukraine. Results. The price relationship between the bond markets of countries with different levels of development has been considered. For the basic indicators, characterizing the main parameters of the bond market the analysis of the influence of the US bond market to the domestic market, determined correlations between the rates of return on ten-year bonds. It has been established that the time series of the rate on ten-year bonds have signs of nonstationarity. Based on the identified nonstationarity time series were analyzed for cointegration. It is determined that the modeling-level rate bonds in Ukraine can be improved by applying advanced Sapsan the value of the rate of the bonds in the United States. Conclusions. The results do not indicate the manifestation of a dependence between the value of the rates of ten-year bonds in the United States and Ukraine. Also there is no dependence between the current growth rate of bonds. A more detailed analysis also showed the absence of long-term balance between the rates of these bonds. The analysis of the interaction between equity markets and bond between them showed that the existing dual influence should be viewed through the prism of external factors that can lead to very different behavior of these markets, on the one hand they are competitors, in terms of raising capital, on the other in some periods, they are characterized by complementarity.

Hedge Fund Pitch and Persuasion (a)

This field-based case uses the experiences of an equity analyst at his first job post–MBA to explore challenges of persuading a boss to support an action that the analyst determined would benefit the firm. In the A case, Fred Hill had been at his job for two years and believed he had come across a fresh idea—a long stock position in J. C. Penney (JCP). The company was misunderstood by the market, had a catalyst, and the valuation was cheap, all the things his boss usually required to initiate a size position in the portfolio. Hill knew it would take multiple conversations, clear analytical deliverables, and a passionate pitch with the boss to get him comfortable enough to buy JCP. Hill had intended to introduce the stock briefly at the meeting as a prelude to a larger pitch in the next day or two, but the tables had turned and it was time to do it now. The analysis had to be right and the communication crisp or Hill would be fired. At the end of the case, Hill's job is to convince his boss to buy more JCP stock. The A case includes an Excel supplement with Hill's valuation of JCP and would be suitable for an introductory finance class in addition to management communication. The B case provides Hill's actual pitch, his boss's responses, and the challenge to communicate effectively the reasons to stay with the position during the volatile days that accompanied any new investment in the stock market. Excerpt UVA-BC-0272 Apr. 18, 2019 Hedge Fund Pitch and Persuasion (A) Fred Hill, the 30-year-old special situations equity analyst for the $ 1 billion hedge fund Nelson Ridge Partners, grabbed the notebook from his desk and stepped into the conference room for the firm's morning meeting. It was 9:00 a.m. on August 22, 2003. Around the oak table were four other analysts for the multistrategy fund responsible for evaluating event-driven, merger-arbitrage, distressed-debt, and technology-investment opportunities in the US stock and bond markets and making recommendations to the firm's portfolio manager, Mark Savage. Savage, a 45-year-old with a formidable physique, penetrating eyes, and a notorious temper, entered the room, trailed by the firm's trader, Big Rob. Savage fixed the first analyst in his gaze. “So, what have we got?” Listening as he took notes, Savage fired questions at each analyst who defended and made recommendations on their existing portfolio positions. At the end of each analyst's update, Savage was legendary for thundering, “Well, what have you got that's fresh?” Hill noticed in his two years at the fund that Savage liked to push his analysts, intimidate them, to test their convictions on their stock recommendations. “To last in the firm,” Hill said, “you had to know your stuff and be able to get it across under pressure.” Hill believed that effectively communicating a stock had nearly as much importance as the idea itself. He prided himself on generating creative and thorough ideas. “But without persuading Savage to buy my stock, and to buy a sufficiently large position,” Hill said, “an analyst's impact on the fund and ultimately my compensation would be hurt.” . . .

Sovereign Bonds Since Waterloo

This paper studies external sovereign bonds as an asset class. We compile a new database of 220,000 monthly prices of foreign-currency government bonds traded in London and New York between 1815 (the Battle of Waterloo) and 2016, covering 91 countries. Our main insight is that, as in equity markets, the returns on external sovereign bonds have been sufficiently high to compensate for risk. Real ex-post returns averaged 7% annually across two centuries, including default episodes, major wars, and global crises. This represents an excess return of around 4% above US or UK government bonds, which is comparable to stocks and outperforms corporate bonds. The observed returns are hard to reconcile with canonical theoretical models and with the degree of credit risk in this market, as measured by historical default and recovery rates. Based on our archive of more than 300 sovereign debt restructurings since 1815, we show that full repudiation is rare; the median haircut is below 50%.

Interrelation and Spillover Effects Between Stocks and Bonds: Cross-Market and Cross-Asset Evidence

This paper examines the behaviour of stock and bond markets across four major international countries. The results confirm the view that same asset-cross country return correlations and spillovers increase over time. However, the same in not true with variance and covariance behaviour. Volatility spillovers across countries exhibit a substantial amount of time-variation, however, there is no evidence of trending in any direction. Equally, cross asset-same country correlations exhibit both negative and positive values. Further, we report an inverse relation between same asset-cross country return correlations and cross asset-same country return correlations i.e., the stock return correlation across countries increases at the same time the stock and bond return correlation within each country declines. Moreover, results show that the stock and bond return correlations exhibit commonality across countries. Results also demonstrate that stock returns lead movement in bond returns, while US stock and bond returns have predictive power other country stock and bond returns. In terms of the markets analysed, Japan exhibit a distinct nature compared with those of Germany, the UK and the US. The results presented here provide a detailed characterisation of how asset interact both with each other and cross countries and should be of interest to portfolio managers, policy-makers and those interested in modelling cross market behaviour.

The performance of US bond mutual funds

We evaluate the performance of the US bond mutual fund industry using a comprehensive sample of bond funds over a long time period from January 1998 to February 2017. In this one study, we examine bond fund selectivity, market timing and performance persistence. We evaluate bond funds relative to their self-declared benchmarks and in terms of both gross-of-fee returns and net-of-fee returns. We document considerable abnormal performance among funds both to the fund (gross returns) and to the investor (net returns). Bond fund performance is found to be superior in the post financial crisis period. However, past strong performance cannot be relied upon to predict future performance. Finally, while some funds exhibit market timing ability; we find a predominance of negative market timing among US bond mutual funds.