Working Papers
“Expectation-Driven Term Structure of Equity and Bond Yields,” (with Ming Zeng), 2022
Abstract: Recent findings on the term structure of equity and bond yields pose serious challenges to existing equilibrium asset pricing models. This paper presents a new equilibrium model of subjective expectations to explain the joint historical dynamics of equity and bond yields (and their yield spreads). Equity/bond yields movements are mainly driven by subjective dividend/GDP growth expectations. Yields on short-term dividend claims are more volatile because short-term dividend growth expectation mean-reverts to its less volatile long-run counterpart. Procyclical slope of equity yields is due to the counter-cyclical slope of dividend growth expectations. The correlation between equity returns/yields and nominal bond returns/yields switched from positive to negative after the late 1990s, mainly owing to a stronger correlation between real GDP growth and real dividend growth expectations, and only partially due to procyclical inflation. Dividend strip returns are predictable and the strength of predictability decreases with maturity due to underreaction to dividend news and hence predictable dividend forecast revisions. The model is also consistent with the data in generating persistent and volatile price-dividend ratios, excess return volatility, and momentum
“Subjective Expectations and Equilibrium Yield Curves,” 2023
Abstract: The stylized facts in the historical dynamics of U.S. Treasury bond yields – a trend in long-term yields, business cycle movements in short-term yields, and a level shift in yield spreads – reflect key features that the pricing kernel of any equilibrium model should have. This paper presents an equilibrium asset pricing model with subjective expectations to jointly explain these puzzling facts. The trend is generated by subjective expectations of long-run GDP growth and inflation, which share similar patterns to the neutral rate of interest (r Star) and trend inflation (pi Star) estimates in the literature. Cyclical movements in yields and spreads are mainly driven by expected short-run GDP growth and inflation. The less-frequent inverted yield curves (and steeper curve) observed after the 1990s are due to the recent secular stagnation and procyclical inflation expectations.
“Inflation Risk, Ambiguity, and the Cross-Section of Stock Returns,“ (with Ming Zeng), 2023 R&R at Journal of Financial Economics
Abstract: Inflation premia among individual stocks are moderate on average, yet their magnitude increases by 1.6% to 3.2% per month when ambiguity is high. This finding aligns with an equilibrium model where investor concerns about model misspecification and uses the worst-case inflation model to price stocks. Stocks whose prices decline with unfavorable realized inflation risk also co-move negatively with ambiguity, leading to a large ambiguity premium. Meanwhile, higher exogenous inflation-ambiguity correlation makes stocks with higher inflation betas better hedges for ambiguity. Empirically, the monthly inflation premium is 0.20% under negative correlation but drops to -1.94% under positive correlation. Our findings are robust at the industry-level and imply that the time-varying inflation premium in the stock market is predominantly influenced by the ambiguity premium. This novel interpretation is unrelated to explanations based on inflation cyclicality, investor sentiment, or macroeconomic disagreement.
“Equity Price Responses and the Fed Information Effect,” (with Simon Gilchrist and Ei Yang), 2024
Abstract: We find that the cash-flow component of high-frequency changes in dividend strip price responses positively to orthogonalized monetary policy surprises around FOMC announcements for the post-2005 period. The effect is stronger for shorter-maturity dividend strips. Using monthly data, the information effects identified using SVAR IV are sample dependent, but they are robust and strong using SVAR with sign restrictions and high frequency identification. To rationalize the results, we build a New Keynesian model with information asymmetries about the state of economy between the Fed and private agents. Monetary policy surprises contain both contemporaneous shocks to economic fundamentals and monetary policy shocks. Information effect dominates when the impact of the first component is bigger. In addition, our estimation with simulated data confirms that SVAR with sign restrictions can recover the structural shocks.
Publications
Ambiguity, Nominal Bond Yields, and Real Bond Yields
– American Economic Review: Insights, June 2020
Confidence, Bond Risks, and Equity Returns
– Journal of Financial Economics, December 2017
Work in Progress
“International Bond Yields and FX Markets: A Joint Equilibrium Model,” (with Ming Zeng)
“QQQ as an Alternative to Treasury Bonds during the Pandemic,” (with Ming Zeng)
Policy Notes
“Knightian Uncertainty as a Potential Driver of Recent Equity and Bond Market Movements” (with Liam Lindsay and Jonathan Witmer), March 2020
“The Canadian Energy Sector: A Natural Hedge to Supply Shock Risks” January 2020
“Potential drivers of a snapback in long-term yields,” (with Jonathan Witmer), June 2018
