Time-varying short-horizon predictability

We present a pricing kernel that summarizes well the main features of the dynamics of interest rates and risk in postwar U.S. data and use it to uncover how the pricing kernel has moved with the short rate in this data. Our findings imply that standard monetary models miss an essential link between the central bank instrument and the economic activity that monetary policy is intended to affect, and thus we call for a new approach to monetary policy analysis. We sketch a new approach using an economic model based on our pricing kernel. The model incorporates the key relationships between policy and risk movements in an unconventional way: the central bank's policy changes are viewed as primarily intended to compensate for exogenous business cycle fluctuations in risk that threaten to push inflation off target. This model, while an improvement on standard models, is considered just a starting point for their revision. It leads to critical questions that researchers need to answer as they continue to revise their approach to monetary policy analysis. Copyright © 2009 by the National Bureau of Economic Research.

The term structure spread and future changes in long and short rates in the G7 countries: Is there a puzzle?

Neftci (1984) proposed a nonparametric test procedure for determining whether business cycles are asymmetric in the sense that contractions are steeper than expansions. He found evidence of this type of asymmetry in postwar quarterly U.S. unemployment variables.' This comment identifies a probable error in Neftci's empirical work that reverses the significance of his results for the unemployment rate, and it suggests that this test may have low power and be sensitive to measurement error.

This research is an experimental investigation into the changing nature of individual and collective risk aversion during financial decision making. In experimental asset markets the market mechanism results in an overly optimistic view of the value of an asset if a business cycle expansion is perceived, while the reverse is true in the business cycle contraction. Theses empirical findings provide a behavioural basis for theoretical models of asset pricing which contain a time varying risk aversion factor and add to the literature which attempts to explain the asset premium puzzle.

Whether the equilibria towards which economic variables gravitate are stable or exhibit historic path dependence (i.e. hysteresis) is of central importance for the efficacy of stabilization policy. Given that such hysteresis is a natural consequence of nonlinearity in the conditional mean of the data generating process, we lest for the presence of hysteretic path dependence by examining the time series properties of monthly U.S. aggregate and disaggregate data over the post Bretton Woods period 1971-1993. Our results suggest that such nonlinearity is indeed present and capable of representation using bilinear and threshold autoregressive models, estimates implying strong asymmetry in the behaviour of our series with recessionary periods being inherently more‘'noisy’. Finally, we consider generalized threshold vector autoregressive models where threshold regimes are conditioned on the sign of the change in the growth rate of industrial production (i.e. the ‘business cycle’). These models reveal that cyclical behaviour of unemployment and the real wage is complex, being procyclical during business cycle expansions but countercyclical and independent, respectively, during contractions.

Recent Changes in the U.S. Business Cycle

This study revisits business cycle duration dependence in G7 countries by controlling for foreign recessions, defined as the number of other G7 countries in a recession. Estimates from regime switching logit models show that the monthly likelihood of ending an expansion roughly doubles for every extra G7 country in recession, but the end of foreign recessions do not affect the ending of recessions. They also show that recessions are duration dependent in all G7 countries, but expansions only in the United States and Germany. The economic importance of foreign recessions and duration in driving business cycle phase changes vary across countries.

Appendix R: U.S. Business Cycle Expansions and Contractions

We employ the GARCH-MIDAS model to examine whether low-frequency macroeconomic variables help to explain the high-frequency volatility of the foreign investors’ net purchase in Korean stock market. The estimation results show that business cycle expansion along with high production growth, high inflation and low unemployment rate predicts high volatility in the near future. Higher interest rate and lower money growth are also likely to lead to higher volatility of foreign investors’ net purchase. We also find that domestic macroeconomic variables, relative to the US variables, have a stronger correlation with the future volatility of foreign investors’ net purchase.

This paper tests for business cycle symmetry in G7 countries during the post-World War II period using a number of tests, each reflecting alternative definitions of business cycle asymmetry. The tests are applied to monthly coincident economic indicators of business cycles. This found that business cycles in the US are characterized by both longitudinal (deepness) and transversal (steepness and sharpness) asymmetries: further, it is found that asymmetric transition probabilties and time irreversibility are due to nonlinearities. On the contrary, business cycles in Germany exhibits a symmetric behaviour. Between these extremes are the other countries, for which at least one of the tests here considered rejects the null of cyclical symmetry. Particularly, business cycle is characterized by deepness and sharpness in Canada, asymmetry in persistence in France and Japan, and asymmetric transition probabilities in France and United Kingdom.

In this paper we analyse the dynamics of business cycles in the G7 countries. Our aim is to answer the question of whether growth varies (in an absolute sense) over the business cycle, and hence to examine whether the simple two‐phase characterization (downturn/upturn) is an appropriate description of the business cycle. To study growth over the cycle, we estimate single‐country equations and then a pooled regression that takes into account the important interactions of international business cycles. The results confirm the steepness asymmetry of the growth cycles and show that growth varies systematically within upturns and downturns. These are consistent with the notion of deepness asymmetry which implies that contractions are more pronounced in the later stages of a downturn whereas expansions are stronger immediately after troughs.

PurposeThis paper aims to investigate the performance of various return forecasting variables and methods in Saudi Arabia and Malaysia. The authors document that market excess returns in Saudi Arabia are predicted by changes in oil prices, the dividend yield and inflation, whereas the equity premium in Malaysia is predicted only by the US market excess returns. In both countries, the authors find that the diffusion index is the best forecasting method and stock return predictability is stronger in expansions than in recessions. To interpret the findings, the authors perform two tests. The empirical results suggest irrational pricing in Malaysia and rationally time-varying expected returns in Saudi Arabia.Design/methodology/approachThe authors apply the state-of-the-art in-sample and out-of-sample forecasting techniques to predict stock returns in Saudi Arabia and Malaysia.FindingsThe Saudi equity premium is predicted by oil prices, dividend yield and inflation. The Malaysian equity premium is predicted by the US market excess returns. In both countries, the authors find that the diffusion index is the best forecasting method. In both countries, predictability is stronger in expansions than in recessions. The tests suggest irrational pricing in Malaysia and rationality in Saudi Arabia.Practical implicationsThe empirical results have some practical implications. The fact that stock returns are predictable in Saudi Arabia makes it possible for policymakers to better evaluate future business conditions, and thus to take appropriate decisions regarding economic and monetary policy. In Malaysia, the results of this study have interesting implications for portfolio management. The fact that the Malaysian market seems to be inefficient suggests the presence of strong opportunities for sophisticated investors, such as hedge and mutual funds.Originality/valueFirst, there are no papers that have studied the return predictability in Saudi Arabia in spite of its importance as an emerging market. Second, the methods that combine all predictive variables such as the diffusion index or the kitchen sink methods have not been implemented in emerging markets. Third, this paper is the first study to deal with time-varying short-horizon predictability in emerging countries.

The long and the short of the risk-return trade-off

This paper estimates a threshold monetary policy rule model for the USA, UK and Japan to investigate if monetary policy changes depend on business cycle conditions, i.e. recessions and expansions of the economy. Then, the paper evaluates the policy implications of this monetary policy rule. Using a long span of data, the paper provides clear‐cut evidence that, while during expansions the monetary authorities of the above countries follow the Taylor rule, during recessions they tend to abandon this policy rule and follow a passive monetary policy focused on interest rate smoothing over time. As shown in the paper, this passive monetary policy can not dampen the volatility effects of negative demand or supply macroeconomic shocks on the economy.

In order to determine exactly when the housing bubble burst and to examine the co-movement of housing price and the real growth of output for individual G7 countries (U.S., U.K., Canada, Germany, France, Italy, and Japan), this study adopted Hamilton’s Markov-switching model (1989). This study found that the housing price for the individual countries showed procyclical movement with the real growth of output during the 1970s, 80s, and 90s and the financial shock in 2008. These findings suggest that the FIML Markov-switching model of Yoon (2006) is very useful for determining the common international business cycle between housing price and the real growth of output in the G7 countries. In addition, extremely large shocks, such as oil shocks, cause procyclical housing price movement with the real growth of output, including the burst housing bubble in 2008.