Hostname: page-component-76fb5796d-dfsvx Total loading time: 0 Render date: 2024-04-26T07:15:15.465Z Has data issue: false hasContentIssue false
  • English
  • Français

Inferring Stock Duration Around FOMC Surprises: Estimates and Implications

Published online by Cambridge University Press:  21 December 2020

Zhanhui Chen Open the ORCID record for Zhanhui Chen [Opens in a new window]
Zhanhui Chen*
Affiliation:
Hong Kong University of Science and Technology, Department of Finance
*
chenzhanhui@ust.hk
Get access Rights & Permissions [Opens in a new window]

Abstract

Discount rates affect stock prices directly via the discount-rate channel or indirectly via the cash-flow channel because expected future cash-flow growth varies with the discount rate. The traditional Macaulay duration captures the effect from the discount-rate channel. I propose a novel duration measure, the effective equity duration, to capture the effects from both channels. I estimate it around unexpected policies in the federal funds rates. I find that the equity yield curve is hump-shaped because expected future cash-flow growth increases with the discount rate. The effective equity duration captures information other than monetary policy risk.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 57 , Issue 2 , March 2022 , pp. 669 - 703
Copyright
© The Author(s), 2020. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

I am grateful for detailed comments from Jennifer Conrad (the editor) and Andrei Gonçalves (the referee), which significantly improved this article. I also thank Jules van Binsbergen, Utpal Bhattacharya, Jie Cao, Ling Cen, Darwin Choi, Tarun Chordia, Ilan Cooper, Zhi Da, Paul Ehling, Fangjian Fu, Michael Gallmeyer, Niels Gormsen, Burton Hollifield, Jianfeng Hu, Wenxi Jiang, Kai Li, Roger Loh, Abhiroop Mukherjee, Dragon Tang, Sheridan Titman, John Wei, Yizhou Xiao, Jialin Yu, and Chu Zhang and seminar participants at the Chinese University of Hong Kong, the University of Hong Kong, Hong Kong Polytechnic University, Hong Kong University of Science and Technology, and the 2018 Society for Financial Studies (SFS) Cavalcade Asia-Pacific for helpful comments. I acknowledge financial support from the Hong Kong University of Science and Technology and the Research Grants Council of Hong Kong (General Research Fund 16502020). I thank Bowen Yang and Chuyi Yang for the excellent assistance with collecting Federal Open Market Committee (FOMC) announcement data.

References

Ai, H.; Bansal, R.; Im, J.; and Ying, C.. “A Model of the Macroeconomic Announcement Premium.” Working Paper, Duke University (2018).Google Scholar
Backus, D.; Boyarchenko, N.; and Chernov, M.. “Term Structures of Asset Prices and Returns.” Journal of Financial Economics, 129 (2018), 1–23.10.1016/j.jfineco.2018.04.005CrossRefGoogle Scholar
Bansal, R.; Miller, S.; Song, D.; and Yaron, A.. “The Term Structure of Equity Risk Premia.” Working Paper, Duke University (2019).10.3386/w25690CrossRefGoogle Scholar
Bernanke, B. S., and Kuttner, K. N.. “What Explains the Stock Market’s Reaction to Federal Reserve Policy?” Journal of Finance, 60 (2005), 1221–1257.10.1111/j.1540-6261.2005.00760.xCrossRefGoogle Scholar
Binsbergen, J. H. v.; Brandt, M.; and Koijen, R. S. J.. “On the Timing and Pricing of Dividends.” American Economic Review, 102 (2012), 1596–1618.10.1257/aer.102.4.1596CrossRefGoogle Scholar
Binsbergen, J. H. v.; Hueskes, W.; Koijen, R. S. J.; and Vrugt, E. B.. “Equity Yields.” Journal of Financial Economics, 110 (2013), 503–519.10.1016/j.jfineco.2013.08.017CrossRefGoogle Scholar
Binsbergen, J. H. v., and Koijen, R. S. J.. “The Term Structure of Returns: Facts and Theory.” Journal of Financial Economics, 124 (2017), 1–21.10.1016/j.jfineco.2017.01.009CrossRefGoogle Scholar
Binsbergen, J. H. v., and Koijen, R. S. J.. “Predictive Regressions: A Present-Value Approach.” Journal of Finance, 65 (2010), 1439–1471.10.1111/j.1540-6261.2010.01575.xCrossRefGoogle Scholar
Boguth, O.; Carlson, M.; Fisher, A. J.; and Simutin, M.. “Leverage and the Limits of Arbitrage Pricing: Implications for Dividend Strips and the Term Structure of Equity Risk Premia.” Working Paper, Arizona State University (2012).Google Scholar
Campbell, J. Y. “A Variance Decomposition for Stock Returns.” Economic Journal, 101 (1991), 157–179.10.2307/2233809CrossRefGoogle Scholar
Campbell, J. Y.; Chacko, G.; Rodriguez, J.; and Viceira, L. M.. “Strategic Asset Allocation in a Continuous-Time VAR Model.” Journal of Economic Dynamics and Control, 28 (2004), 2195–2214.10.1016/j.jedc.2003.09.005CrossRefGoogle Scholar
Campbell, J. Y.; Giglio, S.; Polk, C.; and Turley, R.. “An Intertemporal CAPM with Stochastic Volatility.” Journal of Financial Economics, 128 (2018), 207–233.10.1016/j.jfineco.2018.02.011CrossRefGoogle Scholar
Campbell, J. Y.; Polk, C.; and Vuolteenaho, T.. “Growth or Glamour? Fundamentals and Systematic Risk in Stock Returns.” Review of Financial Studies, 23 (2010), 305–344.10.1093/rfs/hhp029CrossRefGoogle Scholar
Campbell, J. Y., and Vuolteenaho, T.. “Bad Beta, Good Beta.” American Economic Review, 94 (2004), 1249–1275.10.1257/0002828043052240CrossRefGoogle Scholar
Chabi-Yo, F., and Loudis, J.. “The Conditional Expected Market Return.” Journal of Financial Economics, 137 (2020), 752–786.10.1016/j.jfineco.2020.03.009CrossRefGoogle Scholar
Chen, L.; Da, Z.; and Larrain, B.. “What Moves Investment Growth?” Journal of Money, Credit and Banking, 48 (2016), 1613–1653.10.1111/jmcb.12360CrossRefGoogle Scholar
Chen, L., and Zhao, X.. “Return Decomposition.” Review of Financial Studies, 22 (2009), 5213–5249.10.1093/rfs/hhp017CrossRefGoogle Scholar
Chen, S., and Li, T.. “A Unified Duration-Based Explanation of the Value, Profitability, and Investment Anomalies.” Working Paper, City University of Hong Kong (2019).Google Scholar
Chen, Z., and Yang, B.. “In Search of Preference Shock Risks: Evidence from Longevity Risks and Momentum Profits.” Journal of Financial Economics, 133 (2019), 225–249.10.1016/j.jfineco.2019.01.004CrossRefGoogle Scholar
Chordia, T.; Sarkar, A.; and Subrahmanyam, A.. “An Empirical Analysis of Stock and Bond Market Liquidity.” Review of Financial Studies, 18 (2004), 85–129.10.1093/rfs/hhi010CrossRefGoogle Scholar
Cochrane, J. H. “The Dog That Did Not Bark: A Defense of Return Predictability.” Review of Financial Studies, 21 (2008), 1533–1575.10.1093/rfs/hhm046CrossRefGoogle Scholar
Da, Z. “Cash Flow, Consumption Risk, and the Cross-Section of Stock Returns.” Journal of Finance, 64 (2009), 923–956.10.1111/j.1540-6261.2009.01453.xCrossRefGoogle Scholar
Dechow, P. M.; Sloan, R. G.; and Soliman, M. T.. “Implied Equity Duration: A New Measure of Equity Risk.” Review of Accounting Studies, 9 (2004), 197–228.10.1023/B:RAST.0000028186.44328.3fCrossRefGoogle Scholar
DeMiguel, V.; Nogales, F. J.; and Uppal, R.. “Stock Return Serial Dependence and Out-of-Sample Portfolio Performance.” Review of Financial Studies, 27 (2014), 1031–1073.10.1093/rfs/hhu002CrossRefGoogle Scholar
Dew-Becker, I.; Giglio, S.; Le, A.; and Rodriguez, M.. “The Price of Variance Risk.” Journal of Financial Economics, 123 (2017), 225–250.10.1016/j.jfineco.2016.04.003CrossRefGoogle Scholar
Engsted, T.; Pedersen, T. Q.; and Tanggaard, C.. “Pitfalls in VAR Based Return Decompositions: A Clarification.” Journal of Banking and Finance, 36 (2012), 1255–1265.10.1016/j.jbankfin.2011.11.004CrossRefGoogle Scholar
Fama, E. F., and French, K. R.. “The Cross-Section of Expected Stock Returns.” Journal of Finance, 47 (1992), 427–465.10.1111/j.1540-6261.1992.tb04398.xCrossRefGoogle Scholar
Giglio, S.; Kelly, B.; and Kozak, S.. “Equity Term Structures Without Dividend Strips Data.” Working Paper, Yale University (2020).10.2139/ssrn.3533486CrossRefGoogle Scholar
Giglio, S.; Maggiori, M.; and Stroebel, J.. “Very Long-Run Discount Rates.” Quarterly Journal of Economics, 130 (2015), 1–53.10.1093/qje/qju036CrossRefGoogle Scholar
Gonçalves, A. S. “Reinvestment Risk and the Equity Term Structure.” Journal of Finance, forthcoming (2021a).10.1111/jofi.13035CrossRefGoogle Scholar
Gonçalves, A. S. “The Short Duration Premium.” Journal of Financial Economics, forthcoming (2021b).10.1016/j.jfineco.2021.04.019CrossRefGoogle Scholar
Gormsen, N. J., and Lazarus, E.. “Duration-Driven Returns.” Working Paper, University of Chicago (2019).10.2139/ssrn.3359027CrossRefGoogle Scholar
Gorodnichenko, Y., and Weber, M.. “Are Sticky Prices Costly? Evidence from the Stock Market.” American Economic Review, 106 (2016), 165–199.10.1257/aer.20131513CrossRefGoogle Scholar
Gürkaynak, R. S.; Sack, B.; and Swanson, E. T.. “Do Actions Speak Louder Than Words? The Response of Asset Prices to Monetary Policy Actions and Statements.” International Journal of Central Banking, 1 (2005), 55–93.Google Scholar
Hasler, M.; Khapko, M.; and Marfè, R.. “Should Investors Learn about the Timing of Equity Risk?” Journal of Financial Economics, 132 (2019), 182–204.10.1016/j.jfineco.2018.11.011CrossRefGoogle Scholar
Holden, C. W., and Stacey, J.. “Liquidity Measurement Problems in Fast, Competitive Markets: Expensive and Cheap Solutions.” Journal of Finance, 69 (2014), 1747–1785.10.1111/jofi.12127CrossRefGoogle Scholar
Jiang, H., and Sun, Z.. “Reaching for Dividends.” Journal of Monetary Economics, 115 (2019), 321–338.10.1016/j.jmoneco.2019.08.003CrossRefGoogle Scholar
Lettau, M., and Ludvigson, S. C.. “Expected Returns and Expected Dividend Growth.” Journal of Financial Economics, 76 (2005), 583–626.10.1016/j.jfineco.2004.05.008CrossRefGoogle Scholar
Lucca, D. O., and Moench, E.. “The Pre-FOMC Announcement Drift.” Journal of Finance, 70 (2015), 329–371.10.1111/jofi.12196CrossRefGoogle Scholar
Lustig, H.; Stathopoulos, A.; and Verdelhan, A.. “The Term Structure of Currency Carry Trade Risk Premia.” Working Paper, Stanford University (2018).10.1257/aer.20180098CrossRefGoogle Scholar
Menzly, L.; Santos, T.; and Veronesi, P.. “Understanding Predictability.” Journal of Political Economy, 112 (2004), 1–47.CrossRefGoogle Scholar
Miller, S. H. “The Term Structures of Equity Risk Premia in the Cross-Section of Equities.” Working Paper, Duke University (2020).Google Scholar
Nelson, C. R., and Siegel, A. F.. “Parsimonious Modeling of Yield Curves.” Journal of Business, 473–489.10.1086/296409CrossRefGoogle Scholar
Neuhierl, A., and Weber, M.. “Monetary Momentum.” Working Paper, University of Chicago (2018).CrossRefGoogle Scholar
Neuhierl, A., and Weber, M.. “Monetary Policy Communication, Policy Slope, and the Stock Market.” Journal of Monetary Economics, 108 (2019), 140–155.10.1016/j.jmoneco.2019.08.005CrossRefGoogle Scholar
Novy-Marx, R. “The Other Side of Value: The Gross Profitability Premium.” Journal of Financial Economics, 108 (2013), 1–28.10.1016/j.jfineco.2013.01.003CrossRefGoogle Scholar
Ozdagli, A. K. “Financial Frictions and the Stock Price Reaction to Monetary Policy.” Review of Financial Studies, 31 (2018), 3895–3936.Google Scholar
Ozdagli, A. K., and Velikov, M.. “Show Me the Money: The Monetary Policy Risk Premium.” Journal of Financial Economics, 135 (2020), 320–339.10.1016/j.jfineco.2019.06.012CrossRefGoogle Scholar
Ozdagli, A. K., and Weber, M.. “Monetary Policy through Production Networks: Evidence from the Stock Market.” Working Paper, University of Chicago (2019).Google Scholar
Savor, P., and Wilson, M.. “Asset Pricing: A Tale of Two Days.” Journal of Financial Economics, 113 (2014), 171–201.10.1016/j.jfineco.2014.04.005CrossRefGoogle Scholar
Schröder, D., and Esterer, F.. “A New Measure of Equity and Cash Flow Duration: The Duration-Based Explanation of the Value Premium Revisited.” Journal of Money, Credit, and Banking, 48 (2016), 857–900.10.1111/jmcb.12320CrossRefGoogle Scholar
Schulz, F. “On the Timing and Pricing of Dividends: Comment.” American Economic Review, 106 (2016), 3185–3223.10.1257/aer.20131416CrossRefGoogle Scholar
Wahal, S. “The Profitability and Investment Premium: Pre-1963 Evidence.” Journal of Financial Economics, 131 (2019), 362–377.10.1016/j.jfineco.2018.09.007CrossRefGoogle Scholar
Weber, M. “Cash Flow Duration and the Term Structure of Equity Returns.” Journal of Financial Economics, 128 (2018), 486–503.10.1016/j.jfineco.2018.03.003CrossRefGoogle Scholar
Supplementary material: PDF

Chen et al. supplementary material

Chen et al. supplementary material

Download Chen et al. supplementary material(PDF)
PDF 332.6 KB