Email me (Paul.Soderlind at unisg.ch) if you want copies of any of these papers.
We examine the daily activity and performance of a large panel of individual investors in Sweden's Premium Pension System in the period 2000 to 2010. We find that active investors outperform passive investors, and that there is a causal effect of fund changes on performance. Chosen funds outperform discarded funds over all the horizons we study. This outperformance is most significant for changes made within an asset class and towards funds with better recent past performance. While activity is beneficial for the individual investor, extreme flows out of mutual funds affect funds' net asset value negatively for all investors.
Keywords: Coordinated fund changes, defined contribution, 401(k)
JEL Classification Numbers: G11, G23, H55
Download the paper from SSRN or Internet Appendix or Matlab/Octave code for the panel regression with Driscoll-Kraay standard errors.
Previous studies of liquidity in the foreign exchange (FX) market span short time periods or focus on specific measures of liquidity. In contrast, we provide the first comprehensive study of FX liquidity and commonality over more than two decades and a cross-section of forty exchange rates. We show that FX liquidity deteriorates with risk in FX, stock, bond, and money markets, and it comoves with liquidity in bond and stock markets. We also show that commonality in FX liquidities increases in distressed markets and it is stronger for countries with high-quality institutions, financial integration, and price stability.
Keywords: exchange rates, liquidity, transaction costs, commonality, low-frequency data
JEL Classification Numbers: C15, F31, G12, G15
Download the paper from SSRN or the internet appendix (with additional details and results).
We explain the currency carry trade performance using an asset pricing model in which factor loadings are regime-dependent rather than constant. Empirical results show that a typical carry trade strategy has much higher exposure to the stock market and is mean-reverting in regimes of high FX volatility. The findings are robust to various extensions. Our regime-dependent pricing model provides significantly smaller pricing errors than a traditional model. Thus, the carry trade performance is better explained by a time-varying systematic risk that increases in volatile markets, suggesting a partial resolution of the Uncovered Interest Rate parity puzzle.
Keywords: carry trade, factor model, FX volatility,
liquidity, smooth transition regression, time-varying betas
JEL Classification Numbers: F31, G15, G11
Download the final WP version on my SSRN page or download appendix with additional results or Matlab/Octave code for the LSTAR regression.
The difference between nominal and real interest rates (break-even inflation) is often used to gauge the market's inflation expectations - and has become an important tool in monetary policy analysis. However, break-even inflation can move in response to shifts in inflation risk premia and liquidity premia as well as to changes in expected inflation. This paper sheds light on this issue by analysing the evolution of US break-even inflation from 1997 to mid-2008. Regression results show that survey data on inflation uncertainty and proxies for liquidity premia are important factors.
Keywords: break-even inflation, liquidity premium, Survey of Professional Forecasters
JEL Classification Numbers: E27, E47
Download the final WP version on my SSRN page or Matlab/Octave code for fitting normal distributions to a histogram (experimental).
We study high-frequency exchange rates over the period 1993-2008. Based on the recent literature on volatility and liquidity risk premia, we use a factor model to capture linear and non-linear linkages between currencies, stock and bond markets as well as proxies for market volatility and liquidity. We document that the Swiss franc and Japanese yen appreciate against the US dollar when US stock prices decrease and US bond prices and FX volatility increase. These safe haven properties materialise over different time granularities (from a few hours to several days) and non-linearly with the volatility factor and during crises. The latter effects were particularly discernible for the yen during the recent financial crisis.
Keywords: exchange rates, high-frequency data, crisis episodes, non-linear effects
JEL Classification Numbers: F31, G15
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An affine yield curve model is estimated on daily Swiss data 2002-2009. The market price of risk is modelled in terms of proxies for uncertainty, which are estimated from interest rate options. The estimated model generates innovations in the 3-month rate that are similar to external evidence of monetary policy surprises - as well as term premia that are consistent with survey data. The results indicate that a surprise increase in the policy rate gives a reasonably sized decrease (-0.25%) in term premia for longer maturities.
Keywords: affine price of risk, interest rate caps, survey data
JEL Classification Numbers: E27, E47
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The forecasting performance of the Livingston survey and traditional prediction models of stock prices is analysed. The survey forecasts look similar to those from a "too large" prediction model: poor out-of-sample performance and too sensitive to recent and irrelevant information.
Keywords: Livingston survey, out-of-sample forecasts, overfitting,
recency bias
JEL Classification Numbers: G12
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A simple consumption-based two-period model is used to study the (theoretical) effects of disagreement on asset prices. Analytical and numerical results show that individual uncertainty has a much larger effect on risk premia than disagreement if (i) the risk aversion is reasonably high and (ii) individual uncertainty is not much smaller than disagreement. Evidence from survey data on beliefs about output growth suggests that the latter is more than satisfied.
Keywords: equity premium, riskfree rate, implied volatility, Survey
of Professional Forecasters
JEL Classification Numbers: C42, G12, E44
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Survey and option data are used to take a fresh look at the equity premium puzzle. Survey data on equity returns (Livingston survey) shows much lower expected excess returns than ex post data. At the same time, option data suggests that investors tend to overestimate the volatility of equity returns. Both facts contribute towards solving the puzzle. However, data on beliefs about output volatility (Survey of Professional Forecasters) shows marked overconfidence. On balance, the equity premium is somewhat less of a puzzle than in ex post data.
Keywords: equity premium puzzle, Livingston survey, S&P 500 options,
Survey of Professional Forecasters
JEL Classification Numbers: G12, E130, E320
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We use a regime-switching approach to model the implementation of SNB monetary policy. The regime-switching technique is crucial for assessing the flexibility inherent in the SNB's monetary policy strategy. The empirical findings support the idea that repo operations are instrumental in smoothing the implementation of monetary policy in normal times, while changes in the official operational target accompanied by the accommodating use of repo operations produce the intended effects in periods of distress. A significant contribution also comes from some new measures designed to improve liquidity in the Swiss franc money market during the financial crisis of 2007-8.
Keywords: implementation of monetary policy, Libor, repo, Swiss franc money
market, regime switching model
JEL Classification Numbers: E5, G15
The effect of monetary policy on financial risk premia is analysed in a simple general equilibrium model with sticky wages and an optimising central bank. Analytical results show that equity risk premia and term premia are higher under inflation targeting than under output targeting, and that inflation risk premia are higher for policies that strike a balance between output and inflation stability (and achieve a social optimum) than for policies that target only one of them.
Keywords: inflation risk premium, equity risk premium, term premium, announcement effects
JEL Classification Numbers: E52, E44, G12
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Stein's lemma is extended to the case where asset returns have skewed and lepto-kurtic distributions. The risk premium is still the negative of the covariance of the excess return with the log SDF. The riskneutral distribution has a simple form, but is a non-trivial transformation of the physical distribution.
Keywords: Risk premium, stochastic discount factor, change of measure
JEL Classification Numbers: G12
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In 1998, Sweden introduced a second tier of mandatory individual accounts in the public pension system. This paper examines investment choice in the Swedish individual account scheme focusing on two aspects of the investment decision: Do workers with high risk in their human capital diversify their overall portfolio by investing their pension funds in low-risk funds? And to what extent do participants exhibit "home bias" and invest in Swedish asset? Two pieces of evidence support rational investment decisions. First, we establish a positive relationship between income and the level of risk. Second, married participants appear to pool their risks. On the other hand, the results show that participants at the bottom of the income distribution take on as much risk as those at the top indicating that they are not diversifying their overall portfolio. Finally, participants employed in sectors that are affected by foreign competition are less likely to diversify their portfolios and invest in foreign assets compared to the public sector. Instead, these workers exhibit "home bias" in their investments.
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Abel (2002) shows that pessimism and doubt in the subjective distribution of the growth rate of consumption reduce the equity premium puzzle. We quantify the amount of pessimism and doubt in survey data on US consumption and income. Individual forecasters are in fact pessimistic, but show marked overconfidence rather than doubt. However, the implications for Abel's model depends on how the empirically heterogeneous beliefs are mapped into beliefs of a representative agent. We use an Arrow-Debreu economy to show that disagreement increases the equity premium. When incorporating this in our estimation, we find little empirical evidence of either overconfidence or doubt.
Keywords: equity premium, riskfree rate, aggregation of beliefs,
Survey of Professional Forecasters, Livingston Survey
JEL Classification Numbers: C42, G12, E44
Download the final WP version on my SSRN page or Matlab/Octave code for fitting normal distributions to a histogram (experimental)
This paper studies if the consumption-based asset pricing model can explain the cross-section of expected returns. The CRRA model and several refinements (habit persistence and idiosyncratic shocks) all imply that the conditional expected return is linearly increasing in the asset's conditional covariance with consumption growth. Results from quarterly data on the 25 Fama-French portfolios suggest that the model has serious problems: there are large and systematic pricing errors. In addition, the estimated time-varying effective risk aversion coefficients appear implausible and are unrelated with most candidates for habit persistence and idiosyncratic risk.
Keywords: consumption-based asset pricing, habit persistence,
idiosyncratic risk, conditional asset pricing
JEL Classification Numbers: G12, E130, E320
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Using an empirical New-Keynesian model with optimal discretionary monetary policy, we estimate key parameters - the central bank's preference parameters; the degree of forward-looking behavior in the determination of inflation and output; and the variances of inflation and output shocks-to match some broad characteristics of U.S. data. Our obtained parameterization implies a small concern for output stability but a large preference for interest rate smoothing, and a small degree of forward-looking behavior in price-setting but a large degree of forward-looking in the determination of output. Our methodology also allows us to carefully examine the consequences of alternative parameterizations and to provide intuition for our results.
Keywords: interest rate smoothing, central bank objectives, forward-looking behavior, minimum-distance estimation
JEL Classification Numbers: E52, E58
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Recent research shows that when commonly estimated dynamic Taylor rules, which are augmented with a lagged interest, are embedded in a variety of macroeconomic models, they imply a greater amount of predictable information about future movements in interest rates than is actually evident in the yield curve. We extend the analysis to consider more generally the predictability of the arguments of the Taylor rule - inflation and the output gap - in addition to the interest rate. Specifically, we compare the predictability of these three variables in a macroeconomic model with a dynamic Taylor rule to their predictability in real-time surveys of macroeconomic forecasters or a VAR model. We find that the strongest evidence against the dynamic Taylor rule is that while it is easy to predict the variables that enter the rule, it is very hard to predict actual interest rate changes. This disparity suggests that dynamic Taylor rules neglect important aspects of monetary policy behaviour.
Keywords: interest rate smoothing, yield curve, survey data, VAR, in-sample overfitting
JEL Classification Numbers: E52, E58, G12
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We summarize some methods useful in formulating and solving Hansen-Sargent robust control problems, and suggest extensions to discretion and simple rules. Matlab, Octave, and Gauss software is provided. We illustrate these extensions with applications to the term structure of interest rates, the time inconsistency of optimal monetary policy, the effects of expectations on the variances of inflation and output, and on whether central banks should make their forecasts public.
Keywords: robustness, model uncertainty, discretion, simple rules
JEL Classification Numbers: L61, E43, E52
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We have put together a set of GAUSS procedures and example programs (updated in Apr 2003) to demonstrate the methods discussed in the paper. These programs use Paul's procs and dll files with Lapack code for the Schur decomposition and the generalized Schur decomposition. You need GAUSS for Windows (3.2.38, 3.5, and 5.0 are tested).
We have also written a MatLab/Octave version of the programs discussed above (updated in Nov 2003 to be compatible with Octave 2.1.52). No extra files are needed. Updated versions (July 2007) of some of the routines speed up the calculations considerably.
A structural rational expectations model of U.S. monetary policy is used to make a counterfactual experiment of a strongly inflation averse Federal Reserve Bank. Results for U.S. interest rates, output, and inflation over 1965-1999 are discussed.
Keywords: optimal monetary policy, rational expectations, Kalman filter
JEL Classification Numbers: E31, E43, E52
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We study the inflation uncertainty reported by individual forecasters in the Survey of Professional Forecasters 1969-2001. Three popular measures of uncertainty built from survey data are analyzed in the context of models for forecasting and asset pricing, and improved estimation methods are suggested. Popular time series models are evaluated for their ability to reproduce survey measures of uncertainty. The results show that disagreement is a better proxy of inflation uncertainty than what previous literature has indicated, and that forecasters underestimate inflation uncertainty. We obtain similar results for output growth uncertainty.
Keywords: survey data, Survey of Professional Forecasters, GDP growth, VAR, T-GARCH
JEL Classification Numbers: E31, E37, C53
Download the final WP version on my SSRN page or Matlab/Octave code for fitting normal distributions to a histogram (experimental)
Analysis of financial prices in macroeconomic models rests on two building blocks: the consumption-based asset pricing model and the structure of payoffs. This chapter studies how different modelling choices affect yield curves (real and nominal), risk premia on equity (levered or not), and options. The emphasis is on surveying existing models and to bring out the basic mechanisms and intuition. All results are based on simple stylized facts and analytical pricing expressions.
Keywords: consumption-based asset pricing model, equity premium
puzzle, riskfree rate puzzle, Sharpe ratio, cross-sectional variation in returns
JEL Classification Numbers: G12, E130, E320
This paper analyzes how bond option prices are affected by different types of monetary policy. Analytical results from a general equilibrium model with sticky wages show that employment or output targeting typically give lower bond option prices than inflation targeting.
Keywords: inflation targeting, output targeting, interest rates
JEL Classification Numbers: E52, E44, G12
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Historical estimates of the informational content in the yield curve may not be relevant after a change in monetary policy. This study uses a small dynamic rational expectations model with staggered price setting to study how monetary policy affects the relation between nominal interest rates, inflation expectations, and real interest rates. The benchmark parameters, including the Fed's loss function parameters, are estimated by maximum likelihood on quarterly U.S. data. The policy experiments include stronger inflation targeting and more active monetary policy.
Keywords: optimal monetary policy, inflation expectations, forward interest
rates, Kalman filter estimation
JEL Classification Numbers: E31, E43, E52
Download the final WP version on my SSRN page
This paper studies the relation between fund performance and fund attributes in the Swedish market. Performance is measured as the alpha in a linear regression of fund returns on several benchmark assets, allowing for time-varying betas. The estimated performance is then used in a cross-sectional analysis of the relation between performance and fund attributes such as past performance, flows, size, turnover, and proxies for expenses and trading activity. The results show, among other things, that good performance is to be found among small equity funds, low-fee funds, funds whose trading activity is high, and in some cases, funds with good past performance.
Keywords: flows, persistence, portfolio evaluation, survivorship
bias, style analysis
JEL Classification Numbers: G11, G12, G23
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This note discusses stochastic discount factor (SDF) measures of mutual fund performance. It shows that the most common SDF performance measures can be interpreted as Jensen's alphas.
Keywords: mean-variance intersection, managed portfolios, conditional
alphas and betas
JEL Classifcation Numbers: G11, G12, G23
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The British pound left the ERM on 16 September 1992 after a period of turbulence. UK monetary policy soon shifted to lower short interest rates and an inflation target was announced. This paper uses daily option prices to estimate how the market's probability distribution of the future marks/pound exchange rate and UK and German interest rates changed over the summer and autumn of 1992. The results show, among other things, how various policy decisions affected the market's assessment of the probabilities of realignments and lending rate cuts.
Keywords: interest rates, exchange rates, futures, options, risk neutral
distribution
JEL Classification Numbers: E43, E52, G13
Corrected figure: an error in the print shop ruined Figure 1 of my paper "Market Expectations in the UK Before and After the ERM Crisis" (Economica, 67, 1-18, 2000). It should look like this.
Download the final WP version on my SSRN page
Macro models of monetary policy typically involve forward looking behavior. Except in rare circumstances, we have to apply some numerical method to find the optimal policy and the rational expectations equilibrium. This paper summarizes a few useful methods, and shows how they can be combined with a Kalman filter to estimate the deep model parameters with maximum likelihood. Simulations of a macro model with staggered price setting, interest rate elastic output, and optimal monetary policy illustrate the properties of this estimation approach.
Keywords: unstable roots, Schur decomposition, Kalman filter estimation
JEL Classification Numbers: C32, C61, E52
Download the final WP version on my SSRN page
I have put together a set of GAUSS procedures and an example program (updated in Apr 2003) to demonstrate the methods discussed in the paper. These programs use my procs and dll files with Lapack code for the Schur decomposition and the generalized Schur decomposition. You need GAUSS for Windows (3.2.38, 3.5, and 5.0 are tested).
I have put together a MatLab/Octave of the programs discussed above (updated Apr 2003). No extra files are needed. Updated versions (July 2007) of some of the routines speed up the calculations considerably.
This paper provides evidence on the use of stochastic discount factors in the evaluation of portfolio performance. First we discuss evaluation in this setting, and relate it to traditional mean-variance analysis. We then use Monte Carlo experiments to examine the small sample properties of various generalized method of moment estimators. Overall, the test statistics are fairly well described by their asymptotic distributions, even though serious size distortions are found in some cases. The simulations also show that a significant excess return, or a long sample, is needed to reject neutral performance. Finally, we offer an evaluation of Swedish-based mutual funds. The conditional evaluation indicates that funds may have had non-neutral performance over the sample period as revealed by the predictability of the unconditional performance measure.
Keywords: GMM estimators, intersection and spanning tests,
mean-variance analysis, mutual funds, small sample properties
JEL Classification Numbers: G11, G12, G23
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This paper evaluates the properties of nominal interest rates as indicators of inflation expectations. Are they unbiased? How precise are they? To arrive at robust results, a range of different methods are applied on several S and UK data sets. The results show that the interest rate level is a reasonably good indicator of the level of inflation expectations. However, changes in interest rates are poor indicators of changes in inflation expectations.
Keywords: inflation expectations, real interest rates, forward rates
JEL Classification Numbers: E31, E43, E44, G12
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This paper is a selective survey of new or recent methods to extract information about market expectations from asset prices for monetary policy purposes. Traditionally, interest rates and forward exchange rates have been used to extract expected means of future interest rates, exchange rates and inflation. More recently, these methods have been refined to rely on implied forward interest rates, so as to extract expected future time-paths. Very recently, methods have been designed to extract not only the means but the whole (risk neutral) probability distribution from a set of option prices.
Keywords: interest rates, exchange rates, inflation, options, forward rate
curve, risk neutral distribution
JEL: E43, E52, G13
Download the final WP version on my SSRN page
Some corrections of the paper (pdf).
You can download sample programs for estimating implied probability distributions from option prices (zip file). Please contact Lars E.O. Svensson for sample Gauss programs for estimating yield curves or use the MatLab programs below.
I have put together a MatLab/Octave version of some of the programs discussed above. No extra files are needed.
Cointegration analyses of macroeconomic time series are often not based on fully specified theoretical models. We use a theoretical model to scrutinize common procedures in applied cointegration analysis. Monte Carlo experiments show that (1) some tests of the cointegration vectors do not work well on series generated by an equilibrium business cycle model; (2) cointegration restrictions add little in forecasting; (3) structural VAR models based on weak long run restrictions seem to work well. The main disadvantages of cointegration analysis without strong links to economic theory are that it makes it hard to estimate and interpret the cointegration vectors.
Keywords: cointegration, money demand, common trends, equilibrium business cycle model
JEL Classification Numbers: C32, E32
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This paper is a study of the intervention policy of the Swedish central bank using daily intervention data for the late 1980s. In contrast to the first generation of target zone models, we find that the interventions occur all over the exchange rate band and almost every day. Based on this evidence we estimate an exchange rate target zone model with intra-marginal interventions. The results go a long way towards explaining the well-established hump-shaped exchange rate distribution, and lack of non-linearities.
Keywords: exchange rates, mean reversion, intra-marginal interventions
JEL Classification Numbers: F31
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This paper tests the well-known real business cycle model of Kydland and Prescott (1988), using spectral methods for linear filters. Model spectra, coherencies, phase shifts, and correlations are tested against US postwar data using both asymptotic and small-sample distributions. Compared with the model, the data has shorter business cycles, smaller comovements of different macro variables, and less of a leading role for output.
Keywords: spectra, coherency, small-sample distribution
JEL Classification Numbers: C32, E32
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This paper suggests and tests a simple stochastic growth model with international technological links, where growth could be driven either by exogenous or endogenous accumulation of technological knowledge. The main prediction of the model is that per capita output in different countries are cointegrated. The model is tested on data for 15 industrialized countries over the period 1870-1985 and the results show that the model is rejected for most countries, but that it might be valid for the continental European countries.
Keywords: cointegration, international technological links
JEL Classification Numbers: O11, O41, C32
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The Swedish exchange rate band is studied using daily data on exchange rates and interest rate differentials for the 1980s. Applying a number of different statistical and econometrics techniques it is found that the first generation of target zone models cannot provide an adequate explanation of Swedish data. The main reasons are probably intra-marginal interventions by the Swedish central bank and time varying devaluation expectations.
Keywords: exchange rates, interest rates, distribution, conditional variance
JEL Classification Numbers: F31
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Devaluation expectations for the Swedish krona are estimated for the period 1985 to 1992 using daily data for exchange rates and interest rates. The 90 percent confidence intervals for these estimates obtained by the "drift-adjustment method" suggested by Bertola and Svensson are substantially narrower than the 100 percent confidence intervals obtained by the "simplest test" described by Svensson. Estimates for various maturities are used to infer the expected timing of devaluations.
Keywords: exchange rates, interest rates
JEL Classification Numbers: F31
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