For some reason there’s a slew of articles on factor investing and trading models – some are positive and some are scathing. Also, good articles on the impact of economic news in negative rate environments (not much), how banks trade post-Volcker (less equity risk) and a review of CDS markets. On policy, there’s a bunch of articles on how to ease policy when rates are low, the challenge of services-based economies on VAT receipts and whether GDP is the right target for policymakers. Elsewhere, there’s a great history on parties splitting in the UK, how EU populism could be peaking and China’s stealth property easing. Enjoy…
Global Factor Premiums Excellent paper that looks at 24 global factor premiums across the main asset classes via replication and new-sample evidence spanning more than 200 years of data. Reassuringly, the large majority of global factors are strongly present under conservative p-hacking perspectives, with limited out-of-sample decay of the premiums. However, utilizing their deep sample, they find global factor premiums to be not driven by market, downside, or macroeconomic risks.
Alice’s Adventures in Factorland: Three Blunders That Plague Factor Investing According to the authors “factor investing has failed to live up to its many promises. Its success is compromised by three problems that are often underappreciated by investors First, many investors develop exaggerated expectations about factor performance …. Second, for investors using naive risk management tools, factor returns can experience downside shocks far larger than would be expected. Finally, investors are often led to believe their factor portfolio is diversified. Diversification can vanish, however, in certain economic conditions,…”
Factor Momentum and the Momentum Factor Interesting paper that argues that momentum/trend-following strategies are not a standalone risk factor, rather it captures the momentum of returns in other factor models (eg small vs large stocks).
Naïve Buying Diversification and Narrow Framing among Individual Investors Individual investors buying multiple stocks on the same day often use a naïve diversification 1/N heuristic, dividing purchase value equally across stocks. Yet very few investors maintain a 1/N portfolio allocation. Instead, investors appear to narrowly frame their buy-day decision independently of their portfolio, applying the 1/N heuristic only for new purchases. The use of this heuristic decreases, but does not disappear, as financial stakes and investor trading experience increase. These findings indicate that the simple heuristics individual investors use in practice depart further from rationality than is often assumed even in behavioural models of investment decisions.
Why asset managers create subsidies for certain firms Using a theoretical framework and empirical evidence, the column shows that this ‘benchmark inclusion subsidy’ arises because asset managers have incentives to hold some of the equity of firms in the benchmark regardless of the risk characteristics of these firms. As a result, asset managers effectively subsidise investments by benchmark firms. As the asset management industry continues to grow, the benchmark inclusion subsidy will only get bigger.
Blackstone’s Byron Wien Discusses Lessons Learned in His First 80 Years 86 year old vice chair of Blackstone shares some of his wisdom including: “.Network intensely.”, “When your children are grown or if you have no children, always find someone younger to mentor” and “At the beginning of every year think of ways you can do your job better than you have ever done it before.”
Norway’s $1 Trillion Man Talks Brexit, China and Big Tech Yngve Slyngstad, CEO of the world’s biggest sovereign wealth fund, describes how it invests for his grandchildren’s grandchildren.
Financial Markets (7)
Negative Interest Rate Policy and the Influence of Macroeconomic News on Yields Bank of Japan paper finds that macro new surprises has a non-existent or noticeably weaker impact on the bond yields of negative policy rate countries than during preceding zero-rate policy periods.
The Long and Short of It: The Post-Crisis Corporate CDS Market Good primer on the overall structure of the CDS market and its evolution since 2007-8
Do Trade Creditors Possess Private Information? Evidence from Stock Returns Theories of customer supplier relationships hold that the private information of suppliers about buyers explains the use of trade credit even when there is a competitive banking sector. The authors find that the amount of trade credit that a supplier offers to a buyer and the ability of the buyer to pay the trade credit on time are both associated with future buyer abnormal stock returns.
Banks as Regulated Traders Fed paper uses detailed high-frequency regulatory data to evaluate whether trading increases or decreases systemic risk in the U.S. banking sector. They find that U.S. banks had large trading exposures to equity market risk (across equity and fixed income divisions) before the introduction of the Volcker Rule in 2014 and that they curtailed these exposures afterwards. Smaller exposures to credit and currency risk appear not to be affected by the Volker rule.
New Evidence on the Portfolio Balance Approach to Currency Returns Paper finds that CAPM-type currency models that link currency returns to relative debt positions do less well than ones that use valuations (eg PPP)
Improving resilience: banks and non-bank intermediaries In the United States, where bank capital levels increased disproportionately over the decade ending 2017, banks’ share of intermediation rose—from 22% to 25%. Something similar happened in Canada and the United Kingdom, with banks’ shares rising from 27% to 30% and 54% to 56%, respectively. By contrast, the euro area looks completely different. There, banks had accounted for 60% of intermediation prior to the crisis. By 2017, despite capital ratios that lag U.S. norms, banks’ role in intermediation plunged: by 2017, euro-area banks accounted for just over 40% of total intermediation
Market Expectations About Climate Change The authors analyse a direct measure of beliefs around climate change: prices of financial products whose payouts are tied to future weather outcomes. They compare these market expectations to climate model output for the years 2002 to 2018 as well as observed weather station data across eight cities in the US. All datasets show statistically significant and comparable warming trends. When money is at stake, agents are accurately anticipating warming trends in line with the scientific consensus of climate models.
Monetary Policy and Inflation (6)
Monetary Policy Strategies for a Low-Rate Environment Ben Bernanke finds that when neutral interest rates are low and the ELB is a potential problem, “lower-for-longer” policies could still work. He finds that threshold rules (eg once inflation or price levels are above a certain level) tend to provide the best trade-off between theory and practise.
Monetary Policy Options at the Effective Lower Bound: Assessing the Federal Reserve’s Current Policy Toolkit Monetary Policy Options at the Effective Lower Bound: Assessing the Federal Reserve’s Current Policy Toolkit Fed paper finds that over the next decade, there is a 20 to 50 percent probability that the federal funds rate will be constrained by the ELB at some point. They find that forward guidance and balance sheet polices are only modestly effective in speeding up the labour market recovery and return of inflation to 2 percent following an economic slump because of transmission lags.
Empowering central bank asset purchases: the role of financial policies The ECB models the interaction of QE (central bank asset purchases) and bank capital-based financial policies on bank lending. They find that minimum capital requirements curtail excessive credit origination, but that uncertainty about the supervisory oversight often neutralises the impact of QE.
Monetary policy transmission to mortgages in a negative interest rate environment ECB looks at the behaviour of Italian mortgage lenders under negative rates. They find that banks with higher ratios of retail overnight deposits (whose interest rates are less likely to be cut) to total assets charge more on new fixed rate mortgages, though not on variable rate mortgages. This suggests that the funding structure of banks may matter for the transmission of negative policy rates, especially for long-maturity illiquid assets. However, the aggregate economic implications for households are small, suggesting that concerns about inefficient monetary policy transmission to households under modestly negative rates are likely overstated.
Trade Exposure and the Evolution of Inflation Dynamics Fed paper finds that the rising exposure of the U.S. economy to international trade can help explain a significant fraction of the overall decline in responsiveness of aggregate inflation to fluctuations in economic activity. Their estimates indicate that the inflation-output trade-off is about three times larger for low-trade intensity industries compared with their high-trade intensity counterparts.
Inflation: Stress-Testing the Phillips Curve San Fran Fed finds that inflation is barely any connection to economic slack (ie the Phillips curve is flat). Instead, public expectations of inflation are the key driver of current inflation.
Fiscal Policy and Inequality (4)
Structural Transformation and Tax Efficiency Structural transformation has resulted in an increasing share of services in aggregate value-added in advanced and developing countries across the world. The IMF finds that across a large sample of countries a higher share of services in aggregate value-added reduces the VAT efficiency. This is driven by the fact that a large part of the services sector—namely the public and financial services—are exempt from VAT, which in turn contributes to a narrowing of the VAT base.
Inequality of Opportunity, Inequality of Income and Economic Growth In economies characterized by intergenerational rigidities (your parents income determines your income), an increase in income inequality has persistent effects—for example by hindering human capital accumulation— thereby retarding future growth disproportionately. The IMF uses several recently developed internationally comparable measures of intergenerational mobility to confirm that the negative impact of income inequality on growth is higher the lower is intergenerational mobility.
Universal basic income and the Finnish experiment Good summary of how the results of the Finnish UBI experiment were viewed in the blogosphere and social media, and how they fit with longstanding questions over the impact of UBI in developed countries.
The whys and wherefores of short-time work: Evidence from 20 countries Short-time work schemes are a fiscal stabiliser in Europe. Between 2010 and 2013, they were used by 7% of firms, employing 9% of workers in the region. The column uses ECB data to show that firms use the schemes to offset negative shocks and retain high-productivity workers. High firing costs and wage rigidity increase the use of short-time work, which in turn reduces the fall in employment brought on by a recession.
Business Cycle (6)
Living at Home Ain’t Such a Drag (on Spending): Young Adults’ Spending In and Out of Their Parents’ HomeIn the wake of the Great Recession, the share of young adults living with their parents increased sharply, and it has remained elevated since (figure 1a). Initially this may have been due to not having a job, but even as the employed rate has gone up, young adults are staying home. Possible explanations include: lower perceived job stability or income growth expectations, a shift in social interactions towards video games and social media, a cultural shift in theacceptability of living at home, and increased housing costs
Stress Testing Household Debt Fed finds that forecasted delinquency rates for the recent stock of debt are moderately lower than for the stock of debt before the 2007-09 financial crisis, given the same set of shocks. This decline in expected delinquency rates under stress reflects an improvement in debt-to- income ratios and an increase in the share of debt held by borrowers with relatively high credit scores.
Auto Loans Are Not the Next Subprime “If we really want to be concerned about something, I would be more worried about people spending a large chunk of their budget on a depreciating asset than a major economic crash. This seems like more of a personal finance issue than a macro warning sign.”
Here’s Why So Many Americans Feel Cheated By Their Student Loans A social and financial divide is forming — between those who have student debt, and those who do not — that will have ramifications for decades to come.
Wellbeing measurements, Easterlin’s paradox and new growth models: A perspective through gross national happiness There has been considerable criticism of the general reliance on GDP as an indicator of growth and development. One strand of criticism focuses on the inability of GDP to capture the subjective well-being or happiness of a populace. This column examines new growth models, paying particular attention to Bhutan, which has pursued gross national happiness, rather than GDP, since the 1970s. It finds evidence of the Easterlin paradox in Bhutan, and draws out lessons for macroeconomic growth models.
The Ins and Outs of Labor Force Participation Contrary to conventional wisdom, movements in the outflow rate account for most of the variation of the labour force participation rate: the LFPR increases in tight labor markets because fewer workers leave the labour force, not because more nonparticipants enter. The cyclicality of the outflow rate is in turn mechanically driven by a composition effect: in tight labour markets, job seekers find jobs faster and as a result become less likely to leave the labour force
Labour split: new independent group of MPs could break Britain’s political deadlock “Though the contemporary context lends matters a particular urgency, British politics has seen some dramatic political splits before. Back in the late 19th century, Joseph Chamberlain’s Liberal Unionists formed largely to prevent Home Rule for Ireland, albeit ending up being merged into the Conservative Party in 1912. Half a century after Chamberlain’s dramatic move, there were schisms in both Labour and Liberal forces as they wrestled with the dilemma of supporting the Conservative-dominated national government in the 1930s. The so-called National Liberals, again, ended up a virtual vassal of the Tory Party in the post-1945 period.”
EU Elections: Has Populism Peaked? “Drill down, however, and the picture is far more nuanced: France’s National Rally—formerly the National Front—and Hungary’s Fidesz are broadly flat. In fact, the bulk of the gains projected in this study come down to one party: Salvini’s League. And while Europe’s populist parties almost universally share nationalist, EU-sceptic and anti-immigration characteristics, some hail from opposing sides of the traditional left-right political spectrum, making collaboration questionable.”
France’s Yellow Vest Movement Comes of Age At its first “Assembly of Assemblies” in late January, this grassroots democratic revolt brought together many people who had never participated in politics. The two faces of the gilets jaunes There is a growing gulf between the grass-roots gilets, the militant mob involved in violent destruction, and the political wing seeking to keep the main movement together.
Demographics and Immigration (5)
Immigrant Entrepreneurs and Innovation in the U.S. High-Tech Sector Using data from the Annual Survey of Entrepreneurs, the authors find uniformly higher rates of innovation in immigrant-owned firms for 15 of 16 different innovation measures; the only exception is for copyright/trademark. The immigrant advantage holds for older firms as well as for recent start-ups and for every level of the entrepreneur’s education.
Taking stock of household innovations The column examines data from the US Patent and Trademark Office and the US Census Bureau to describe patented household innovations and characteristics of US household inventors, who are predominantly male, white, and US-born. It estimates that in between 2000 and 2011, patented household innovations generated a revenue flow of $1.7 billion
Immigration and Preferences for Redistribution in Europe The authors use a newly assembled data set of immigrant stocks for 140 regions of 16 Western European countries. They find that native respondents display lower support for redistribution when the share of immigrants in their residence region is higher. This negative association is driven by regions of countries with relatively large Welfare States and by respondents at the centre or at the right of the political spectrum.
Demographics and the Natural Rate of Interest in Japan IMF paper finds that demographic change has a significantly negative impact on the natural rate by lowering trend potential growth. They also find that the negative impact has been increasing over time amid stronger demographic headwinds.
When Labor’s Lost: Health, Family Life, Incarceration, and Education in a Time of Declining Economic Opportunity for Low-Skilled Men The economic progress of U.S. men has stagnated in recent decades, with declining labour force participation and weak growth in real earnings, particularly for less educated and non-white men. The authors find several changes men have experienced: the risk of death from drug overdose and suicide has risen substantially, men have been surpassed by women in educational attainment and continue to face the world’s highest rates of incarceration,. Some studies find that “find that the lowering of trade barriers with China around 2000 differentially affected economic opportunities among less-educated men and led to substantial increases in both suicide and opioid overdose mortality rates.”
Credit, financial conditions and the business cycle in China This ECB paper models the Chinese economy, incorporating a financial conditions index for China that captures movements across a range of financial variables, including interest rates and interbank spreads, bond returns, and credit and equity flows. The model suggests that monetary policy, credit and financial conditions have played an important role in shaping China’s business cycle. They find the importance of credit growth in supporting activity during the past decade, particularly the surge in credit following the global financial crisis in 2008. The financial tightening since the end of 2016 has contributed to a modest slowing of credit growth and activity.
Chinese Bond Market and Interbank Market The paper provides an up-to-date overview of Chinese bond markets and highlights two distinct and largely segmented markets: Over-the-Counter based interbank market, and centralized exchange market. The paper explains various bond instruments traded in these two markets, highlighting their inherent connection with the banking system, and many multi-layer regulatory bodies who are interacting with each other in an intricate way.
China Property ‘Stealth Easing’ Spreads in Boost to Home Prices At least 11 cities have eased residency permit rules this year. Moves equivalent to lowering home-buying thresholds
The Chinese Military Speaks to Itself, Revealing Doubts “The increasing scope and frequency of these self-critiques during the tenure of Xi Jinping as chairman of the Central Military Commission casts doubt over the senior party and military leadership’s confidence in the PLA’s ability to prevail in battle against a modern enemy”.
In Huawei battle, signs of US decline The UK has joined Germany in resisting calls to ban Chinese tech, while Washington fails to craft a coherent policy
The Looming Taiwan Crisis “For many years, US policymakers worried that Taiwan would upset the apple cart: not content with the mere trappings of independence, it would opt for the real thing – an unacceptable outcome for the mainland. Now, however, the balancing act is threatened by both China and the US.”
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