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Bond Market Exposures to Macroeconomic and Monetary Policy Risks

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  • Dongho Song

Abstract

The paper estimates a model that allows for shifts in the aggressiveness of monetary policy and time variation in the distribution of macroeconomic shocks. These model features induce variations in the cyclical properties of inflation and the riskiness of bonds. The estimation identifies inflation as procyclical from the late 1990s, when the economy shifted toward aggressive monetary policy and experienced procyclical macroeconomics shocks. Since bonds hedge stock market risks when inflation is procylical, the stock-bond return correlation turned negative in the late 1990s. The risks of encountering countercyclical inflation in the future could lead to an upward-sloping yield curve, like in the data.Received September 11, 2016; editorial decision January 2, 2017 by Editor Stijn Van Nieuwerburgh.

Suggested Citation

  • Dongho Song, 2017. "Bond Market Exposures to Macroeconomic and Monetary Policy Risks," The Review of Financial Studies, Society for Financial Studies, vol. 30(8), pages 2761-2817.
    • Handle: RePEc:oup:rfinst:v:30:y:2017:i:8:p:2761-2817.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhx039
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    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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