The Decline in Asset Return Predictability and Macroeconomic Volatility

75 Pages Posted: 8 May 2017

See all articles by Alex Hsu

Alex Hsu

Georgia Institute of Technology - Scheller College of Business

Francisco Palomino

Board of Governors of the Federal Reserve System

Charles Qian

Citigroup

Date Written: 2017-05

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

JEL Classification: E14, E44, G12, G18

Suggested Citation

Hsu, Alex and Palomino, Francisco and Qian, Charles, The Decline in Asset Return Predictability and Macroeconomic Volatility (2017-05). FEDS Working Paper No. 2017-050, Available at SSRN: https://ssrn.com/abstract=2964441 or http://dx.doi.org/10.17016/FEDS.2017.050

Alex Hsu (Contact Author)

Georgia Institute of Technology - Scheller College of Business ( email )

800 West Peachtree St.
Atlanta, GA 30308
United States
4043851123 (Phone)

Francisco Palomino

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Charles Qian

Citigroup ( email )

388 Greenwich Street
New York, NY 10013
United States

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