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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," 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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    References listed on IDEAS

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    Cited by:

    1. Konstantinos Theodoridis & Haroon Mumtaz, 2015. "Dynamic Effects of Monetary Policy Shocks on Macroeconomic Volatility," Working Papers 101219932, Lancaster University Management School, Economics Department.
    2. Lakdawala, Aeimit & Wu, Shu, 2017. "Federal Reserve credibility and the term structure of interest rates," European Economic Review, Elsevier, vol. 100(C), pages 364-389.
    3. Illenin Kondo & Fabrizio Perri & Sewon Hur, 2016. "Inflation, Debt, and Default," 2016 Meeting Papers 1610, Society for Economic Dynamics.
    4. Fabrizio Perri & Sewon Hur & Illenin O. Kondo, 2018. "Real Interest Rates, Inflation, and Default," Staff Report 574, Federal Reserve Bank of Minneapolis.
    5. Dufour, Alfonso & Stancu, Andrei & Varotto, Simone, 2017. "The equity-like behaviour of sovereign bonds," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 48(C), pages 25-46.
    6. Kim, Jaeho, 2015. "Bayesian Inference in a Non-linear/Non-Gaussian Switching State Space Model: Regime-dependent Leverage Effect in the U.S. Stock Market," MPRA Paper 67153, University Library of Munich, Germany.
    7. Michael D. Bauer & Glenn D. Rudebusch, 2017. "Resolving the Spanning Puzzle in Macro-Finance Term Structure Models," Review of Finance, European Finance Association, vol. 21(2), pages 511-553.
    8. Dergunov, Ilya & Meinerding, Christoph & Schlag, Christian, 2019. "Extreme inflation and time-varying consumption growth," Discussion Papers 16/2019, Deutsche Bundesbank.
    9. Roberto Marfè, 2016. "Labor Rigidity, Ination Risk and Bond Returns," Carlo Alberto Notebooks 461, Collegio Carlo Alberto.
    10. Mohsan Bilal, 2017. "Zeroing in: Asset Pricing at the Zero Lower Bound," 2017 Meeting Papers 377, Society for Economic Dynamics.
    11. Geert Bekaert & Eric Engstrom & Andrey Ermolov, 2016. "Macro Risks and the Term Structure of Interest Rates," NBER Working Papers 22839, National Bureau of Economic Research, Inc.
    12. Bianca De Paoli & Hande Küçük, 2015. "News shocks, monetary policy, and foreign currency positions," Staff Reports 750, Federal Reserve Bank of New York.
    13. Marcello Pericoli, 2018. "Macroeconomics determinants of the correlation between stocks and bonds," Temi di discussione (Economic working papers) 1198, Bank of Italy, Economic Research and International Relations Area.
    14. Nikolay Gospodinov, 2017. "Asset Co-movements: Features and Challenges," FRB Atlanta Working Paper 2017-11, Federal Reserve Bank of Atlanta.
    15. Taeyoung Doh & Shu Wu, 2016. "The Equilibrium Term Structure of Equity and Interest Rates," Research Working Paper RWP 16-11, Federal Reserve Bank of Kansas City, revised 30 Nov 2016.
    16. Shaliastovich, Ivan, 2015. "Learning, confidence, and option prices," Journal of Econometrics, Elsevier, vol. 187(1), pages 18-42.
    17. Guihai Zhao, 2018. "Ambiguity, Nominal Bond Yields and Real Bond Yields," Staff Working Papers 18-24, Bank of Canada.
    18. van Holle, Frederiek, 2017. "Essays in empirical finance and monetary policy," Other publications TiSEM 30d11a4b-7bc9-4c81-ad24-5, Tilburg University, School of Economics and Management.
    19. Michael D. Bauer & Glenn D. Rudebusch, 2017. "Resolving the Spanning Puzzle in Macro-Finance Term Structure Models," Review of Finance, European Finance Association, vol. 21(2), pages 511-553.

    More about this item

    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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