The Decline in Asset Return Predictability and Macroeconomic Volatility

Alex Hsu (), Francisco Palomino and Charles Qian
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Alex Hsu: https://www.scheller.gatech.edu/directory/faculty/hsu/index.html

No 2017-050, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: We document strong U.S. stock and bond return predictability from several macroeconomic volatility series before 1982, and a significant decline in this predictability during the Great Moderation. These findings are robust to alternative empirical specifications and out-of-sample tests. We explore the predictability decline using a model that incorporates monetary policy and shocks with time-varying volatility. The decline is consistent with changes in both policy and shock dynamics. While an increase in the response to inflation in the interest-rate policy rule decreases volatility, more persistent and less volatile shocks explain the lower predictability.

Keywords: Asset return predictability; Great Moderation; Monetary policy; Time-varying macroeconomic volatility (search for similar items in EconPapers)
JEL-codes: E14 E44 G12 G18 (search for similar items in EconPapers)
Pages: 75 pages
Date: 2017-05
New Economics Papers: this item is included in nep-fmk and nep-mac
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:2017-50

DOI: 10.17016/FEDS.2017.050

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