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MTCAP - Macroeconomic Trends, Cycles, and Asset Prices


Unit Director: Carlo Favero

The research of this unit focuses on the decomposition of macroeconomic and policy variables in trends and cycles to assess their effects on Asset Prices and Asset Returns. 

Project 1: Trends and Cycles in Short-term rate and the term structure 

Short-term  rates are modelled via a two components decomposition a stochastic trend and a cycle. The stochastic trend, is determined by the drivers of that natural rate, productive growth, demographic age distribution, and inflation expectations. The cyclical variations in short-term rates are associated exclusively with  monetary policy through the deviation of output from its potential value and deviations of inflation form the CB target. The impact of trend and cycles in short-term rates on the entire term structure its analyzed by decomposing yields at all maturities in a trend driven by the path of expected short rates and a cyclical components commonly labelled as term-premium. 

Project 2: Macro Trends and Factor Timing 

This project  studies the link between macroeconomic variables and asset prices. We document two novel empirical facts. First, the price of well-known systematic (characteristics-based) risk factors, like SMB and HML, is anchored to macroeconomic trends related to inflation and real economic activity. Second, factor prices temporarily deviate from their macro trends generating factor risk premia predictability. Intuitively, future factor returns are low (high) when prices are above (below) their level warranted by the macroeconomy. We provide evidence for this mechanism for different factors, both in- and out-of-sample. This predictability translates into economic gains from factor timing for investors. Finally, our approach leads to an estimated stochastic discount factor that displays sizable time variation when benchmarked against standard long-run risk or habit models.