CARLO AMBROGIO FAVERO

The objective of this course is to illustrate the relevance to model (stochastic) trends and cycles in macro-finance and in factor models.   We shall then illustrate the empirics by considering  the Bond market and the Stock market .  Data and draft versions of the R, MATLAB  and E-VIEWS codes for replication are made available here, as well as a reading list for the discussion.

EXAM: The exam consists of an essay that each student has to write individually. Each essay should be based on one of the articles included in the reading list. Different  students are not allowed to work on the same article. Each essay should contain three compulsory parts: 1) Replication of the main results in the original article 2) A referee's report on the article 3) A proposal, based on 1) and 2), for further research on the topic of the article. 

  1. Time Series Models of Trends and Cycles and Predictability of Financial Returns.

Returns at different Horizons 
Co-trending and predictability
Cointegration and Predictability of Stock Returns


Bansal, Ravi and Dana Kiku (2011) "Cointegration and long-run asset allocation," Journal of Business & Economic Statistics, Vol. 29, No. 1, pp. 161-173.
Campbell, John Y (2017) Financial decisions and markets: a course in asset pricing: Princeton University Press.
Campbell J.Y., A.W. Lo and A.C.MacKinley (1997) The Econometrics of Financial Markets, Princeton University Press, Chapter 7 
Campbell J.Y. and R.J. Shiller (1987) "Cointegration and Tests of Present Value Models", Journal of Political Economy, 95, 5, 1062-1088
Cho T. and C. Polk(2020), Asset Pricing with Price Levels, mimeo  LSE
Cochrane J. (2005) "Asset Pricing: Revised Edition", Princeton University Press, Chapter 20
Cochrane J. (2011) "Presidential address: Discount rates," The Journal of Finance, Vol. 66, No.4, pp. 1047-1108.
Fama E. and K.French(1988), Permanent and Temporary Components of Stock Prices, Journal of Political Economy, Vol. 96, No. 2, pp. 246-273
Lettau M. and S.Ludvigson(2004) Understanding Trend and Cycle in Asset Values: Reevaluating the Wealth Effect on Consumption. American Economic Review, 2004, March, Volume 94, No. 1, pages 276-299.
Lettau, Martin, and Sydney Ludvigson, 2005, Expected Returns and Expected Dividend Growth, Journal of Financial Economics, 76, 583-626
Lettau, M., and S. Ludvigson. "Consumption, Aggregate Wealth and Expected Stock Returns." Journal of Finance, 56 (2001), 3, 815-849.

SLIDES, EVIEWS CODES, DATABASE

2. VARs and CVARs

     Statistical Representation
     Identification and Hypothesis-Testing with multiple cointegrating vectors
     Using VAR: Alternative Representation  
     Identification of Shocks: Statistical and Narrative 
     Description of VAR models
     Cointegration and Multivariate trend-cycle decompositions
     Global VARs
     Cointegrated VAR and Present Value Models
     VAR-based model evaluation in Macroeconomics

Campbell J.Y. and R.J. Shiller (1987) "Cointegration and Tests of Present Value Models", Journal of Political Economy, 95, 5, 1062-1088 
Engle, Robert F and Clive WJ Granger (1987) "Co-integration and error correction: Representation, estimation, and testing," Econometrica, Vol. 55, No. 2, pp. 251-276.
Hamilton J.(1994) Time-Series Analysis, Princeton University Press
Johansen, S. (1995) Likelihood-based inference in cointegrated vector autoregressive models, Oxford University Press.
Pesaran M.H., T. Schuerman and S.M.Weiner (2004) "Modeling Regional Interdependencies Using a Global Error-Correcting Macroeconometric Model", Journal of Business & Economic Statistics,22,02, pp. 129-162
Romer C. (2020) The narrative approach to establishing causation in macroeconomics, Keynes Lecture University of Cambridge, https://www.keynesfund.econ.cam.ac.uk/keynes-lecture-1920

SLIDES, LECTURE NOTES,

3. An Introduction to the Empirical Forecasting of Bond yields and Inflation with R (Students' Presentation) 

DATABASE IN EXCEL (zipped file) 
AN INTRODUCTION TO  FORECASTING INFLATION AND INTEREST RATES WITH R 
EXERCISE 1,PROPOSED SOLUTION,AN R CODE TO IMPLEMENT THE SOLUTION,preparePackages.R 

Favero, Carlo A, Alessandro Melone, and Andrea Tamoni (2022) “Monetary policy and bond prices with drifting equilibrium rates,” Journal of Financial and Quantitative Analysis, 1–26 

4. Models for the Term Structure

Asset Pricing with Time-Varying Expected Returns
Physical and Risk Neutral Probabilities
Bond YTM and HPR
Modelling the Term Structure
Forward Rates and Instantaneous Forward Rates
On the Importance of the Risk Premia
Factor Models of the Term Structure
SLIDES, LECTURE NOTES
DATA AND R CODES FOR THE IMPLEMENTATION OF the ACM Affine Term Structure Model
EVIEWS CODES FOR NS INTERPOLANT 

Adrian, Tobias, Richard K Crump, and E.Moench (2013) “Pricing the term structure with linear regressions,” Journal of Financial Economics, 110 (1), 110–138.
Adrian, Tobias, Richard K Crump, and E. Moench (2015) “Regression-based estimation of dynamic asset pricing models,” Journal of Financial Economics, 118 (2), 211–244
Adrian T and H.Wu (2009) The Term Structure of Inflation Expectations. Working paper, Federal Reserve Bank of New York
Bauer, Michael D. and Glenn D. Rudebusch (2020) "Interest Rates under Falling Stars", American Economic Review, Vol. 110, No. 5, pp. 1316-54.
Campbell,J.,and Shiller,R. "Cointegration and Tests of Present Value Models" J.P.E. 95 (1987) 1062-1088
Chen R.R. and L. Scott, (1993) "Maximum Likelihood estimation for a multi-factor equilibrium model of the term structure of interest rates"Journal of Fixed Income, 3, 14-31.
Cochrane J. and M.Piazzesi(2008) "Decomposing the Yield Curve"
Cochrane, JH and M Piazzesi. 2005. Bond Risk Premia. American Economic Review 95, 138—160
Diebold and Li (2005) "Forecasting the Term Structure of Government Bond Yields",  Journal of Econometrics
Diebold F.X., Piazzesi M and G.D. Rudebusch(2005) "Modeling Bond Yields in Finance and Macroeconomics", Appendix 
Gürkaynak, RS, B Sack, and JH Wright. 2006, The US Treasury Yield Curve
Ireland P.(2015) “Bond Risk Premia, Monetary Policy and the Economy” mimeo
Nelson C.R. and A.F. Siegel (1987) "Parsimonious modelling of yield curves", Journal of Business, 60, 473-489
Piazzesi M. and A. Ang (2003) A No-Arbitrage Vector Autoregression of Term Structure Dynamics with Macroeconomic and Latent Variables" Journal of Monetary Economics Volume 50, Issue 4, May 2003, 745-7

 

5. Recent Developments in Modelling Drifting Interest Rates (Students Presentation)  
Bauer, Michael D. and Glenn D. Rudebusch (2020) "Interest Rates under Falling Stars", American Economic Review, Vol. 110, No. 5, pp. 1316-54.
Duffee, Gregory R. (2013) "Forecasting interest rates " in G. Elliott, C. Granger, and A. Timmermann eds. Handbook of Economic Forecasting, Vol. 2 of Handbook of Economic
Forecasting: Elsevier, Chap. 10, pp. 385-426. 
Favero C.A., A. Melone and A.Tamoni(2020) "Monetary Policy and Bond Prices with Drifting Equilibrium Rates and Diagnostic Expectations" 
Favero C.A. and R. Fernandez-Fuertes(2023) Modelling the Term Structure with Trends in Yields and Cycles in Excess Returns
Goodhart C., M. Pradhan (2020) "The Great Demographic Reversal", Palgrave Mac Millan
Mian, A. R., L. Straub, and A. Sufi. 2020. The saving glut of the rich. Working Paper, National Bureau of Economic Research.
Mian, A. R., L. Straub, and A. Sufi. 2021. What explains the decline in r*? rising income inequality versus demographic shifts. Becker Friedman Institute for Economics Working Paper
DATA AND R CODES FOR THE IMPLEMENTATION of the FF Affine Term Structure Model with trends and cycles

6. Forecasting Inflation  
Bernanke B., O.Blanchard(2023), What Caused the U.S. Pandemic-Era Inflation? 
ECB Economic Bullettin(2018) Interpreting Recent Developments in Market Based Indicators of Longer Term Inflation Expectations
Garcia A. and Werner T.(2010) Inflation risk and Inflation Risk Premia, ECB Working Paper 1162
Gürkaynak, RS, B Sack, and JH Wright. 2006, The US Treasury Yield Curve
Gürkaynak, RS, B Sack, and JH Wright. 2010. The TIPS Yield Curve and Inflation Compensation. American Economic Journal: Macroeconomics 2(1):70—92
Kitsul Y. and JH Wright(2012) The Economics of  Options-Implied Inflation Probability Density Functions, NBER WP 18195
Pflueger C.E. and L.Viceira “Inflation Indexed Bonds and the Expectations Hypothesis”
Pflueger C.E. and L.Viceira "Return Predictability in The Treasury Market: Real Rates, Inflation and Liquidity"

An excellent presentation by Ricardo Reis on Inflation Risk 

SLIDES, CODES AND DATA IN Eviews, CODES and DATA for the Replication of Bernanke and Blanchard in MATLAB  

7. Consumption and Asset Price Fluctuation, long-run risk

Consumption and Asset Pricing Puzzles
Long-run Consumption Growth
Stock returns and Cointegration between Consumption and Wealth
Consumption and Present Value Models for the Stock Market
Long-Run Risk

LECTURE NOTES

READINGS:

Campbell J.Y. (2018) "Financial Decisions and Markets", Princeton University Press
Cochrane J.(2001) "Asset Pricing", Princeton University Press
Cochrane J.(2005) Financial Markets and the Real Economy, mimeo Chicago GSB.
Cochrane J.Y. and Hansen L.(1992) "Asset Pricing Explorations for Macroeconomics, NBER Macroeconomics Annual, vol.7, pp 115-165.
Epstein L. and S.Zin,(1989), "Substitution, Risk Aversion and the Temporal Behaviour of Consumption and Asset returns: A theoretical framework" Econometrica, 57, 937-968
Hansen L.P., J.C. Heaton and N.Li(2004) "Consumption Strikes Back?",
Julliard P.(2004) "Labor Income Risk and Asset Returns", Job Market Paper, Princeton University
M.Lettau and S.Ludvigson (2001) "Consumption, Aggregate Wealth and Expected Stock Returns", Journal of Finance, 56,3, 815-854
Parker J.A and C.Julliard(2003) "Consumption Risk and Cross-Sectional Returns", NBER Working Paper 9538

8. The debate on  long-run risk (Students' Presentation) 
Bansal R.(2007) Long-run risk and Financial Markets, Federal Reserve Bank of St Louis  
Bansal Yaron (2002) Risk for the Long-run: a Potential Resolution of asset pricing puzzles
Bansal, Dittmar and Kiku (2007) "Cointegration and Consumption risk in Asset Returns" Review of Financial Studies
Beeler J and J.Campbell (2009) "The long-run risks model and aggregate asset prices: an empirical assessment"
Sargent T (2007) Commentary to Bansal, Long-run risk and Financial Markets, Federal Reserve Bank of St Louis

 

9.  Stock Market Returns Predictability and Cointegration.

SLIDES,NOTES,  

(a) Cointegration and Stock Market Predictability
Boudoukh, J., Michaely, R., Richardson, M. and M. Roberts, 2007, On the Importance of Measuring Payout Yield: Implications for Empirical Asset Pricing, Journal of Finance.
Favero CA, A.Gozluklu and A.Tamoni(2010) "Demographic Trends, the Dividend-Price Ratio and the Predictability of Long-Run Stock Market Returns"
Lettau, Martin, and Stijn Van Nieuwerburgh, 2008, Reconciling the Return Predictability Evidence, Review of Financial Studies, 21, 4, 1607-1652.
Lettau, M., and S. Ludvigson. "Consumption, Aggregate Wealth and Expected Stock Returns." Journal of Finance, 56 (2001), 3, 815-849.
Robert J. Shiller.(1981) "Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?" American Economic Review 71 , 421-436. 21

(b) The Econometrics of Stock Market Predictability
Boudoukh, Jacob, Richardson, Matthew and Robert F. Whitelaw, 2008, The Myth of Long-Horizon Predictability, The Review of Financial Studies, 21, 4, 1577-1605.
Campbell, John Y., and Samuel B. Thomson, 2008, Predicting Excess Stock Returns Out of Sample: Can Anything Beat the Historical Average?, The Review of Financial Studies, 21, 1509-1531.
Cochrane John, 2006, The dog that did Not Bark: a Defense of Return Predictability, NBER WP 12026
Goyal, Amit, and Ivo Welch, 2008, A Comprehensive Look at the Empirical Performance of Equity Premium Prediction. The Review of Financial Studies, 21-4, 1455-1508.
Ribeiro R.M.(2002) "Predictable dividends and returns" mimeo, GSB, University of Chicago.
Pesaran M.H. and A.Timmermann (1995) `Predictability of Stock Returns: Robustness and Economic Significance', Journal of Finance, 50, 4, 1201-1228
Valkanov, R., 2003. Long-horizon regressions: Theoretical results and applications. Journal of Financial Economics 68, 201--232. 33

10.  Recent Developments: Factor Models, Trend Cycle Decompositions and Returns Predictability (Students' Presentation) 
Ang A.(2014) Asset Management. A Systematic Approach to Factor Investing, Oxford University Press
Chernov, Mikhail, Lars A Lochstoer, and Stig RH Lundeby (2021) “Conditional dynamics
and the multi-horizon risk-return trade-off,” The Review of Financial Studies (Forthcoming),
Cho T. and C. Polk(2020), Asset Pricing with Price Levels, mimeo  LSE
Fama, Eugene and Kenneth R. French, 1988, Dividend Yields and Expected Stock Returns, Journal of Financial Economics, 22, 3-26. 
Favero C.A., A.Melone, A. Tamoni (2023). Predicting Anomaly Returns with Price Deviations
Dong L.,Y. Li,Rapach D.E. and G.Zhou (2022) Anomalies and Expected Market Returns, Forthcoming, Journal of Finance